AUDITING OF BANKS

A project

Submitted to:

Mr. Virgilio J. SeballeCPA, MBA, CFSA, CIA, CISA

Faculty

As partial fulfillment for the requirementsof the course subject in

Bachelor of ScienceIn

AccountancyAuditing 2, Applied Auditing

Submitted by:

Team Leader:Rovel D. Lagonoy

Members:Jerald Bho

Mark delos SantosGerald John Acoyong

Juliet Semodio

Table of Contents

I. Overview of the Industry

II. Audit Procedures in Bank

III. Test of Control and Substantive Test of BanksA. Internal Control QuestionnaireB. Audit ProgramsC. Working PapersD. Flowcharts

IV. Audit Report

I. Overview of the Industry

A bank is a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers with capital deficits to customers with capital surpluses. Banking is generally a highly regulated industry, and government restrictions on financial activities by banks have varied over time and location. Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and ATM. Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending. Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account. Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to.

a) Regulation

Currently in most jurisdictions commercial banks are regulated by government entities and require a special bank licence to operate. Usually the definition of the business of banking for the purposes of regulation is extended to include acceptance of deposits, even if they are not repayable to the customer's order—although money lending, by itself, is generally not included in the definition. Unlike most other regulated industries, the regulator is typically also a participant in the market, i.e. a government-owned (central) bank. Central banks also typically have a monopoly on the business of issuing banknotes. However, in some countries this is not the case. In the UK, for example, the Financial Services Authority licences banks, and some commercial banks (such as the Bank of Scotland) issue their own banknotes in addition to those issued by the Bank of England, the UK government's central bank. Banking law is based on a contractual analysis of the relationship between the bank (defined above) and the customer—defined as any entity for which the bank agrees to conduct an account.

The law implies rights and obligations into this relationship as follows:

1. The bank account balance is the financial position between the bank and the customer: when the account is in credit, the bank owes the balance to the customer; when the account is overdrawn, the customer owes the balance to the bank.

2. The bank agrees to pay the customer's cheques up to the amount standing to the credit of the customer's account, plus any agreed overdraft limit.

3. The bank may not pay from the customer's account without a mandate from the customer, e.g. a cheque drawn by the customer.

4. The bank agrees to promptly collect the cheques deposited to the customer's account as the customer's agent, and to credit the proceeds to the customer's account.

5. The bank has a right to combine the customer's accounts, since each account is just an aspect of the same credit relationship.

6. The bank has a lien on cheques deposited to the customer's account, to the extent that the customer is indebted to the bank.

7. The bank must not disclose details of transactions through the customer's account—unless the customer consents, there is a public duty to disclose, the bank's interests require it, or the law demands it.

8. The bank must not close a customer's account without reasonable notice, since cheques are outstanding in the ordinary course of business for several days.

These implied contractual terms may be modified by express agreement between the customer and the bank. The statutes and regulations in force within a particular jurisdiction may also modify the above terms and/or create new rights, obligations or limitations relevant to the bank-customer relationship.

Some types of financial institution, such as building societies and credit unions, may be partly or wholly exempt from bank licence requirements, and therefore regulated under separate rules.

The requirements for the issue of a bank licence vary between jurisdictions but typically include:

1. Minimum capital2. Minimum capital ratio3. 'Fit and Proper' requirements for the bank's controllers, owners, directors, and/or senior

officers4. Approval of the bank's business plan as being sufficiently prudent and plausible.

b) Types of banks

Banks' activities can be divided into retail banking, dealing directly with individuals and small businesses; business banking, providing services to mid-market business; corporate banking, directed at large business entities; private banking, providing wealth management services to high net worth individuals and families; and investment banking, relating to activities on the financial markets. Most banks are profit-making, private enterprises. However, some are owned by government, or are non-profit organizations.

Types of retail banks

Commercial bank : the term used for a normal bank to distinguish it from an investment bank. After the Great Depression, the U.S. Congress required that banks only engage in banking activities, whereas investment banks were limited to capital market activities. Since the two no longer have to be under separate ownership, some use the term "commercial bank" to refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses.

Community banks : locally operated financial institutions that empower employees to make local decisions to serve their customers and the partners.

Community development banks : regulated banks that provide financial services and credit to under-served markets or populations.

Postal savings banks : savings banks associated with national postal systems. Private banks : banks that manage the assets of high net worth individuals. Historically a

minimum of USD 1 million was required to open an account, however, over the last years many private banks have lowered their entry hurdles to USD 250,000 for private investors.[citation needed]

Offshore banks : banks located in jurisdictions with low taxation and regulation. Many offshore banks are essentially private banks.

Savings bank : in Europe, savings banks take their roots in the 19th or sometimes even 18th century. Their original objective was to provide easily accessible savings products to all strata of the population. In some countries, savings banks were created on public initiative; in others, socially committed individuals created foundations to put in place the necessary infrastructure. Nowadays, European savings banks have kept their focus on retail banking: payments, savings products, credits and insurances for individuals or small and medium-sized enterprises. Apart from this retail focus, they also differ from commercial banks by their broadly decentralised distribution network, providing local and regional outreach—and by their socially responsible approach to business and society.

Building societies and Landesbanks: institutions that conduct retail banking. Ethical banks : banks that prioritize the transparency of all operations and make only

what they consider to be socially-responsible investments. A Direct or Internet-Only bank is a banking operation without any physical bank

branches, conceived and implemented wholly with networked computers.

Types of investment banks

Investment banks "underwrite" (guarantee the sale of) stock and bond issues, trade for their own accounts, make markets, and advise corporations on capital market activities such as mergers and acquisitions.

Merchant banks were traditionally banks which engaged in trade finance. The modern definition, however, refers to banks which provide capital to firms in the form of shares rather than loans. Unlike venture capital firms, they tend not to invest in new companies.

Commercial Bank

A commercial bank is a type of financial intermediary and a type of bank. Commercial banking is also known as business banking. It is a bank that provides checking accounts, savings accounts, and money market accounts and that accepts time deposits. [1] After the implementation of the Glass-Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S. law, some use the term "commercial bank" to refer to a bank or a division of a bank primarily dealing with deposits and loans from corporations or large businesses. In some other jurisdictions, the strict separation of investment and commercial banking never applied. Commercial banking may also be seen as distinct from retail banking, which involves the provision of financial services direct to consumers. Many banks offer both commercial and retail banking services.

Commercial bank has two possible meanings:

Commercial bank is the term used for a normal bank to distinguish it from an investment bank or retail bank.

This is what people normally call a "bank". The term "commercial" was used to distinguish it from an investment bank. Since the two types of banks no longer have to be separate companies, some have used the term "commercial bank" to refer to banks that focus mainly on companies. In some English-speaking countries outside North America, the term "trading bank" was and is used to denote a commercial bank. During the great depression and after the stock market crash of 1929, the U.S. Congress passed the Glass-Steagall Act 1933-35 (Khambata 1996) requiring that commercial banks engage only in banking activities (accepting deposits and making loans, as well as other fee based services), whereas investment banks were limited to capital markets activities. This separation is no longer mandatory.

It raises funds by collecting deposits from businesses and consumers via checkable deposits, savings deposits, and time (or term) deposits. It makes loans to businesses and consumers. It also buys corporate bonds and government bonds. Its primary liabilities are deposits and primary assets are loans and bonds.

Commercial banking can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, as opposed to normal individual members of the public (retail banking).

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance by Florentine bankers, who used to make their transactions above a desk covered by a green tablecloth.[2] However, traces of banking activity can be found even in ancient times.

In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are derived. As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign currency into the only legal tender in Rome- that of the Imperial Mint. [3]

The role of commercial banks

Commercial banks engage in the following activities:

processing of payments by way of telegraphic transfer, EFTPOS, internet banking, or other means

issuing bank drafts and bank cheques accepting money on term deposit lending money by overdraft, installment loan, or other means providing documentary and standby letter of credit, guarantees, performance bonds,

securities underwriting commitments and other forms of off balance sheet exposures safekeeping of documents and other items in safe deposit boxes sale , distribution or brokerage, with or without advice, of insurance, unit trusts and

similar financial products as a “financial supermarket” cash management and treasury services merchant banking and private equity financing traditionally, large commercial banks also underwrite bonds, and make markets in

currency, interest rates, and credit-related securities, but today large commercial banks usually have an investment bank arm that is involved in the mentioned activities.

Types of loans granted by commercial banks

Secured loan

A secured loan is a loan in which the borrower pledges some asset (e.g., a car or property) as collateral (i.e., security) for the loan.

Mortgage loan

A mortgage loan is a very common type of debt instrument, used to purchase real estate. Under this arrangement, the money is used to purchase the property. Commercial banks, however, are given security - a lien on the title to the house - until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it.

In the past, commercial banks have not been greatly interested in real estate loans and have placed only a relatively small percentage of assets in mortgages. As their name implies, such financial institutions secured their earning primarily from commercial and consumer loans

and left the major task of home financing to others. However, due to changes in banking laws and policies, commercial banks are increasingly active in home financing.

Changes in banking laws now allow commercial banks to make home mortgage loans on a more liberal basis than ever before. In acquiring mortgages on real estate, these institutions follow two main practices. First, some of the banks maintain active and well-organized departments whose primary function is to compete actively for real estate loans. In areas lacking specialized real estate financial institutions, these banks become the source for residential and farm mortgage loans. Second, the banks acquire mortgages by simply purchasing them from mortgage bankers or dealers.

In addition, dealer service companies, which were originally used to obtain car loans for permanent lenders such as commercial banks, wanted to broaden their activity beyond their local area. In recent years, however, such companies have concentrated on acquiring mobile home loans in volume for both commercial banks and savings and loan associations. Service companies obtain these loans from retail dealers, usually on a nonrecourse basis. Almost all bank/service company agreements contain a credit insurance policy that protects the lender if the consumer defaults.

Unsecured loan

Unsecured loans are monetary loans that are not secured against the borrowers assets (i.e., no collateral is involved). These may be available from financial institutions under many different guises or marketing packages:

bank overdrafts corporate bonds credit card debt credit facilities or lines of credit personal loans

Other types of banks

Central banks are normally government-owned and charged with quasi-regulatory responsibilities, such as supervising commercial banks, or controlling the cash interest rate. They generally provide liquidity to the banking system and act as the lender of last resort in event of a crisis.

Islamic banks adhere to the concepts of Islamic law. This form of banking revolves around several well-established principles based on Islamic canons. All banking activities must avoid interest, a concept that is forbidden in Islam. Instead, the bank earns profit (markup) and fees on the financing facilities that it extends to customers.

c) Accounting for bank accounts

Bank statements are accounting records produced by banks under the various accounting standards of the world. Under GAAP and MAIC there are two kinds of accounts: debit and credit. Credit accounts are Revenue, Equity and Liabilities. Debit Accounts are Assets and Expenses. This means you credit a credit account to increase its balance, and you debit a credit account to decrease its balance.[11]

This also means you debit your savings account every time you deposit money into it (and the account is normally in deficit), while you credit your credit card account every time you spend money from it (and the account is normally in credit).

However, if you read your bank statement, it will say the opposite—that you credit your account when you deposit money, and you debit it when you withdraw funds. If you have cash in your account, you have a positive (or credit) balance; if you are overdrawn, you have a negative (or deficit) balance.

The reason for this is that the bank, and not you, has produced the bank statement. Your savings might be your assets, but the bank's liability, so they are credit accounts (which should have a positive balance). Conversely, your loans are your liabilities but the bank's assets, so they are debit accounts (which should also have a positive balance).

Where bank transactions, balances, credits and debits are discussed below, they are done so from the viewpoint of the account holder—which is traditionally what most people are used to seeing.

Company Profile of BPI

Bank Of The Philippine Islands - Company Profile, Information, Business Description, History, Background Information on Bank Of The Philippine IslandsBPI Building, Ayala Avenue, Paseo De RoxasMakati City, 1200Philippines

Company Perspectives:

Through the years, BPI strove to deliver the highest standards of convenience banking through the ingenuity of technology and creative management. As the recognized "most technologically advanced bank", BPI introduced the first successful automated teller machine (ATM) service in the Philippines. Among BPI's other firsts are: the issuance of the first debit card, the introduction of cashless shopping with the Express Teller Card, the establishment of banking kiosks, the Express Banking Centers, the launching of telephone banking with the Express

Phone, and the use of a Call Center. BPI has distinguished itself by catering to the ever-evolving needs and lifestyles of the public.

History of Bank Of The Philippine Islands

Bank of the Philippine Islands (BPI) is that country's second-largest bank, trailing only Metropolitan Bank & Trust. It is also the Philippines' oldest bank and one of the oldest of all Asian banks. BPI offers a full range of commercial and retail financial services, including corporate finance services, asset management, and brokerage and other financial consulting services. BPI's retail network includes more than 700 branches throughout the Philippines, as well as branches in New York, Hong Kong, and Tokyo. The bank also operates a network of more than 1,200 automated teller machines and more than 8,500 retailer-based point-of-sale machines. In 1999, BPI pioneered online banking in the Philippines with the launch of online bank BPI Direct in 1999. In addition to its banking products and services, BPI has also developed a strong non-life insurance operation, chiefly under subsidiary BPI/MS Insurance Corporation. Listed on the Philippines Stock Exchange, BPI has long been majority controlled by Philippines conglomerate Ayala Corporation.

Founding Asian Banking History in the 19th Century

The increasing trade between Spain and the Philippine Islands created a need for a banking facility in the Spanish colony. A first attempt to establish a colonial bank came in 1828, when King Ferdinand VII called for the creation of a public bank in the Philippines. Yet the actual formation of the bank did not occur until the middle of the century, under the auspices of then colonial governor Antonio de Urbiztondo y Eguia, who took up his post in 1850.

Urbiztondo established the bank the following year in the Royal Custom House in the fortress town of Intramuros. The bank was named El Banco Español Filipino de Isabel 2 in honor of the reigning queen of Spain. Joining the bank's policy board was Antonio de Ayala. The Ayala family and the later Ayala Corporation were to remain intimately related with the bank and with the Philippines' industrial development.

As the first and only public bank in the Philippines--and perhaps the first public bank in all of Southeast Asia--El Banco Español Filipino de Isabel 2 was granted the authority to issue the first paper money in the Philippines. That operation started in 1852, when the bank issued its first pesos fuertes, or 'strong pesos.'

El Banco Español Filipino de Isabel 2 and its successors played a prominent role in financing the development of the Philippines. This included financing for the country's first railroad, and, later, its telephone network, its electric utilities, and the country's first steamship service.

In the meantime, the bank changed its name after Isabel II was dethroned in 1869, becoming more simply El Banco Español Filipino. Nonetheless, the bank remained under the control of Spain. The bank remained in its Intramuros site until nearly the end of the century. However,

the shift in Manila's industrial and commercial activity led the bank to move its offices in 1892 to the Binondo district across the Pasig River.

The development of the sugar industry in the Philippines had opened up new potential banking markets, and the bank petitioned Spain for permission to expand its operations. In 1897, Banco Español Filipino opened its first branch office, Iloilo. The outbreak of the Spanish-American War the following year, however, changing the political situation in the Philippines.

The Philippines became a U.S. possession following the Treaty of Paris of 1898. No longer under Spanish domination, Banco Español Filipino transformed itself into a purely Filipino institution. While the change in the company's name--authorized in 1907--came only in 1912, it nevertheless adopted the name of Bank of the Philippine Islands (BPI). The Spanish influence remained strong, however, and the bank became popularly known as Banco de las Islas Filipinas. Also in 1912, the bank opened its second branch office, in Zamboanga.

BPI continued its money-issuing function during this period, although it was no longer the exclusive issuer of Philippine pesos. With the creation of the Central Bank of the Philippines in 1949, however, BPI lost its money-issuing privileges altogether. The now-independent country began instituting a variety of banking reforms designed to stimulate the growth of the banking system and the creation of new banks, particularly in rural areas. As part of that process, BPI was converted to a private bank. In 1969, the bank's relationship with the Ayala family and businesses strengthened after Ayala Corporation took a majority share in BPI. At that point, BPI became the center of Ayala's banking and, later, insurance interests.

Under Ayala, BPI began an expansion campaign lasting into the next century that firmly positioned it among the Philippines' top banks. Much of BPI's growth came through a stream of acquisitions, starting in 1974 with its purchase of the Peoples Bank and Trust Company. That acquisition significantly helped to build BPI's branch network.

Expansion and Diversification in the 1980s

In 1982, BPI began preparing for the deregulation of the Philippines' banking industry, which enabled it to transform itself into an expanded commercial bank. As part of that effort, BPI acquired Commercial Bank and Trust Company, which specialized in the middle market, in 1981. The growing bank then moved to enter the investment banking field with the purchase of Ayala Investment and Development Corporation in 1982. BPI's relationship with Ayala also enabled it to add an international component that year when it took over Ayala International Finance, based in Hong Kong. BPI made two more significant purchases in 1982 when it acquired Philsec, boosting its new investment banking wing, and Makati Leasing and Financing. The latter purchase helped strengthen its own leasing arm, which was launched in 1980 and made BPI the first Philippine bank to offer leasing facilities.

BPI by then had expanded its operations into the Philippines rural areas after acquiring People's Development Bank, which also held a strong, agribusiness-based loan portfolio, in 1984. That

purchase enabled BPI to meet new government requirements stipulating that agribusiness loans make up at least 20 percent of a bank's loan portfolio. The People's Development Bank acquisition formed the basis of BPI's new subsidiary, BPI Agricultural Bank.

BPI continued its acquisition burst into the mid-1980s. In 1985, the company added Family Bank, at the time a major mortgage and savings bank in the Philippines. Renamed BPI Family Bank, the new subsidiary grew into one of the country's leading consumer lending banks. Also in 1985, BPI stepped up its international component with the purchase of Asian International Bank, based in New York. That office was later converted into a full BPI branch.

"Bancassurance" Leader in the New Century

Alongside its acquisition campaign, BPI displayed its penchant for playing the pioneer in various banking areas during the 1980s and early 1990s. In 1981, the bank became the first in the country to offer access via Automated Teller Machines (ATM). Two years later, BPI extended its ATM network to include its Express Teller system, the first in the country to provide 24-hour access to banking services. Then, in 1987, the bank introduced the Philippines first debit-card system.

BPI's next technological innovation came in 1991 when it introduced its Express Banking Centers. Typically located in shopping malls, BPI's Express Banking Centers operated as mini-banks providing a more limited range of services than full-service banks. Nonetheless, customers were able to open new accounts as well as apply for credit cards and home and car loans.

If BPI had taken a break from external growth, its competitors had not, and by the middle of the 1990s the company had turned over its first-place spot to fast-growing Metropolitan & Trust Corporation. BPI was then forced to content itself with a position in the top three, alongside state-owned Philippine Nation Bank. Yet the opening of the Philippines banking sector to foreign competition for the first time in the mid-1990s set off a new wave of consolidation among the country's banking sector, which at the time counted 38 commercial banks and some 800 rural credit houses.

BPI once again began to grow through acquisition, starting in 1995 with the purchase of First Cavite Savings. The following year, the company struck again, adding CityTrust Banking Corporation. That bank, a specialist consumer services bank, had been ranked number 16 in terms of assets among Philippine banks. The acquisition of CityTrust boosted BPI's branch network to more than 400.

BPI remained relatively stable despite the crisis sweeping through the Asian financial community. By the end of the decade, the bank had completed integrating its newly expanded operations and had begun to make plans for a new growth spurt. In 1998, the bank launched a 24-hour call center providing a broad range of banking services over the telephone.

The following year, BPI began talks for a three-way merger with two other prominent Filipino banks, FarEast Bank and Trust Company and Union Bank. After Union Bank pulled out of the proposed merger, BPI and FarEast went it alone and in November 1999 FarEast agreed to be acquired by BPI for $1.2 billion. The merged operation now claimed--if only temporarily--the top spot in the Philippines' banking sector. The Far East merger also gave the company an insurance subsidiary, FEB Mitsui Marine.

BPI entered new territory in 2000 when it became the first Filipino bank to launch its own online bank, BPI Direct. In that year, too, the bank showed its pioneering mettle again when it acquired FGU Insurance Corporation, Universal Reinsurance Corporation, Ayala Life Assurance, Ayala Health Care and Ayala Plans. These acquisitions gave BPI the right to label itself as the Philippines' first "bancassurance" company. In 2001, FGU merged with FEB Mitsui Marine, creating BPI/MS Insurance Corporation.

As consumer lending slowed amid the difficult economic climate at the beginning of the 2000s, BPI turned toward increasing its corporate lending operations, particularly to the small and medium enterprise (SME) market. Insurance continued to play a central role in BPI's growth strategy, particularly as the bank announced its intention to pursue more insurance acquisitions at the end of 2002. As part of its focus on insurance products, BPI spun off its re-insurance operations into a merger with Malayan Reinsurance Corporation, forming Universal Malayan Reinsurance Corporation in August 2003.

By then, BPI had completed another significant purchase when it bought up DBS Bank Philippines, which enabled the company's thrift banking component to claim the leadership spot in the Philippines. BPI's banking arm now boasted more than 1,200 branch offices in operation. The bank was also one of the most financially sound of all Philippine banks, posting steady increases in its net earnings despite the Asian economic crisis that occurred in the early 2000s. After more than 150 years in existence, BPI remained a top player in the Philippines banking market.

Principal Subsidiaries: Ayala Financial and Insurance Services Inc.; Ayala Health Care Inc.; Ayala Life Assurance Inc.; Ayala Plans, Inc.; BPI Capital Corporation; BPI Computer Systems Corporation; BPI Direct Savings Bank; BPI Express Remittance Corporation; BPI Family Savings Bank; BPI Forex Corporation; BPI Foundation, Inc.; BPI International Finance, Ltd.; BPI Investment Management, Inc.; BPI Leasing Corporation; BPI Operations Management Corporation; BPI Securities Corporation; BPI/MS Insurance Corporation; Santiago Land Development Corporation; Universal Reinsurance Corporation.

Principal Competitors: Citibank; Metropolitan Bank and Trust Co.; Equitable-PCI Bank; Land Bank of the Philippines; Philippine National Bank; Rizal Commercial Banking Corporation; Development Bank of the Philippines; Allied Banking Corporation; United Coconut Planters Bank; China Banking Corporation; Union Bank of the Philippines.

Chronology

Key Dates: 1828: King Ferdinand VII of Spain issues a decree authorizing the formation of Bank in

the Philippines. 1851: El Banco Español Filipino de Isabel 2 is established. 1898: The bank becomes a Filipino institution after United States takes over the

Philippines from Spain. 1912: The bank changes its name to Bank of the Philippine Islands (BPI). 1969: Ayala Corporation acquires control of BPI. 1974: BPI acquires Peoples Bank and Trust Company. 1980: The bank begins leasing operations. 1981: Commercial Bank and Trust Company is acquired, and the first ATMs are

introduced. 1982: The company converts to expanded commercial bank status. 1995: First Cavite Savings is acquired. 1999: Far East Bank and Trust Company is acquired. 2000: BPI Direct internet banking service is launched, and Ayala insurance companies

are acquired. 2002: DBS Bank Philippines is acquired. 2003: The company spins off re-insurance operations into Universal Malayan

Reinsurance Corporation.

Additional Details

Public Company Incorporated: 1851 El Banco Español Filipino de Isabel 2 Employees: 11,554 Net Earnings: P 5.17 billion ($938 million)(2002) Stock Exchanges: Philippines Ticker Symbol: BPI NAIC: 522110 Commercial Banking

II. Audit Procedures in Bank

1. Audits are reviews conducted on a company's financial information by external auditors from a public accounting firm or government agency. Because banks hold depositor funds and provide loans or investment services for customers, bank audits are needed to ensure the bank's solvency. Auditors provide external stakeholders with a positive or negative opinion on a bank's accounting functions and bank policies. Audits are also conducted on the bank's adherence to government regulations; government agencies typically conduct these audits, since private accountants are not thoroughly trained to audit government bank regulations.

Internal Controls

2. Internal controls are the accounting policies and functions a bank follows when processing transactions for customers. Audits test the strength of internal controls and how well bank employees adhere to these controls. Paperwork generated by bank transaction is also reviewed because of the requirements by state law and the Fair Credit Reporting Act. Sensitive information is collected from customers, such as Social Security numbers and driver's license numbers, which must be stored securely on bank premises. Certain information produced by banks must be approved by managers or executives, which is reviewed by auditors to ensure that no transactions occur without proper approval.

Bank customers may request to review the auditor's opinion on the bank, giving them insight into the bank's internal controls strength.

Loan Portfolio

3. Another important audit process is the review of bank liabilities, which includes the amounts lent to individuals, businesses and other banks from their reserves. Auditors review the borrowers repayment ability on the loaned amounts, along with the loan terms and evaluation methods used to determine the reasons for the loan. This information is important because auditors must determine the possibility of loan defaults, which will affect the fractional reserve requirements of the bank. Fractional reserve amounts represent the amount of cash on-hand each bank must have as required by the federal government. Failure to meet this requirement causes a review of the bank's lending and banking procedures, causing customers to lose faith in the bank.

Asset Valuation

4. Bank assets are another crucial part of the auditor's plan when reviewing the bank's procedures. Assets involve any investments the bank has made in equities or companies as part of their operating procedures. Banks lend money to generate interest income,

which helps the bank to pay its operating costs and purchase other investments. Auditors test these investments for risk and material miscalculations, which may lead the bank to lose money on their investments. Losses limit the bank's ability to loan money to borrowers, which is another area banks generate cash flow. Auditors report investment large losses in their audit reports, as these losses signal the inability of the bank to accurately recover losses on bad loans made to borrowers.

a) Circular Regulation in the Philippines

4 October 2004

BANGKO SENTRAL NG PILIPINAS

CIRCULAR NO. 456 Series of 2004

Pursuant to Monetary Board Resolution No. 1351 dated 16 September 2004, the Manual of Regulations for Banks (MORB) and the Manual of Regulations for Non-Bank Financial Institutions (MORNBFI) are hereby amended, as follows:

Section 1. Subsecs. X141.3.c(9) and 4141Q.3.c(9) of the MORB and MORNBFI, respectively, are hereby amended to read, as follows:

Subsecs. X141.3.c(9) and 4141Q.3.c(9) Specific duties and responsibilities of the board of directors

"(9) To constitute the following committees:

(a) Audit committee. The audit committee shall be composed of members of the board of directors, at least two (2) of whom shall be independent directors, INCLUDING THE CHAIRMAN, preferably with accounting, AUDITING, OR RELATED FINANCIAL MANAGEMENT EXPERTISE OR experience. The audit committee provides oversight of the institution's FINANCIAL REPORTING AND CONTROL AND internal and external AUDIT FUNCTIONS. It shall be responsible for the setting up of the internal audit department and for the appointment of the internal auditor as well as the independent external auditor WHO SHALL BOTH REPORT DIRECTLY TO THE AUDIT COMMITTEE. It shall monitor and evaluate the adequacy and effectiveness of the internal control system.

UPON SETTING UP THE AUDIT COMMITTEE, THE BOARD OF DIRECTORS SHALL DRAW UP A WRITTEN CHARTER OR TERMS OF REFERENCE WHICH CLEARLY SETS OUT THE AUDIT COMMITTEE'S AUTHORITY AND DUTIES, AS WELL AS THE REPORTING RELATIONSHIP WITH THE BOARD OF DIRECTORS. THIS CHARTER SHALL BE APPROVED BY THE BOARD OF DIRECTORS AND REVIEWED AND UPDATED PERIODICALLY.

THE AUDIT COMMITTEE SHALL HAVE EXPLICIT AUTHORITY TO INVESTIGATE ANY MATTER WITHIN ITS TERMS OF REFERENCE, FULL ACCESS TO AND COOPERATION BY MANAGEMENT AND FULL DISCRETION TO INVITE ANY DIRECTOR OR EXECUTIVE OFFICER TO ATTEND ITS MEETINGS, AND ADEQUATE RESOURCES TO ENABLE IT TO EFFECTIVELY DISCHARGE ITS FUNCTIONS.

THE AUDIT COMMITTEE SHALL ENSURE THAT A REVIEW OF THE EFFECTIVENESS OF THE INSTITUTION’S INTERNAL CONTROLS, INCLUDING FINANCIAL, OPERATIONAL AND COMPLIANCE CONTROLS, AND RISK MANAGEMENT, IS CONDUCTED AT LEAST ANNUALLY.

(b) CORPORATE GOVERNANCE COMMITTEE. The CORPORATE GOVERNANCE committee SHALL ASSIST THE BOARD OF DIRECTORS IN FULFILLING ITS CORPORATE GOVERNANCE RESPONSIBILITIES. It shall review and evaluate the qualifications of all persons nominated to the board as well as those nominated to other positions requiring appointment by the board of directors. THE COMMITTEE

shall be composed of at least three (3) members of the board of directors, TWO (2) OF WHOM SHALL BE independent directors.

THE CORPORATE GOVERNANCE COMMITTEE SHALL HAVE A WRITTEN CHARTER THAT DESCRIBES THE DUTIES AND RESPONSIBILITIES OF ITS MEMBERS. THIS CHARTER SHALL BE APPROVED BY THE BOARD OF DIRECTORS AND REVIEWED AND UPDATED AT LEAST ANNUALLY.

THE COMMITTEE SHALL BE RESPONSIBLE FOR ENSURING THE BOARD’S EFFECTIVENESS AND DUE OBSERVANCE OF CORPORATE GOVERNANCE PRINCIPLES AND GUIDELINES. IT SHALL OVERSEE THE PERIODIC PERFORMANCE EVALUATION OF THE BOARD AND ITS COMMITEES AND EXECUTIVE MANAGEMENT; AND SHALL ALSO CONDUCT AN ANNUAL SELF-EVALUATION OF ITS PERFORMANCE. THE COMMITTEE SHALL ALSO DECIDE WHETHER OR NOT A DIRECTOR IS ABLE TO AND HAS BEEN ADEQUATELY CARRYING OUT HIS/HER DUTIES AS DIRECTOR BEARING IN MIND THE DIRECTOR’S CONTRIBUTION AND PERFORMANCE (E.G., COMPETENCE, CANDOR, ATTENDANCE, PREPAREDNESS AND PARTICIPATION). INTERNAL GUIDELINES SHALL BE ADOPTED THAT ADDRESS THE COMPETING TIME COMMITMENTS THAT ARE FACED WHEN DIRECTORS SERVE ON MULTIPLE BOARDS.

THE COMMITTEE SHALL MAKE RECOMMENDATIONS TO THE BOARD REGARDING THE CONTINUING EDUCATION OF DIRECTORS, ASSIGNMENT TO BOARD COMMITTEES, SUCCESSION PLAN FOR THE BOARD MEMBERS AND SENIOR OFFICERS, AND THEIR REMUNERATION COMMENSURATE WITH CORPORATE AND INDIVIDUAL PERFORMANCE.

THE CORPORATE GOVERNANCE COMMITTEE SHALL DECIDE THE MANNER BY WHICH THE BOARD’S PERFORMANCE MAY BE EVALUATED AND PROPOSE AN OBJECTIVE PERFORMANCE CRITERIA APPROVED BY THE BOARD. SUCH PERFORMANCE INDICATORS SHALL ADDRESS HOW THE BOARD HAS ENHANCED LONG TERM SHAREHOLDERS’ VALUE.

(c) RISK MANAGEMENT COMMITTEE. THE RISK MANAGEMENT COMMITTEE SHALL BE RESPONSIBLE FOR THE DEVELOPMENT AND OVERSIGHT OF THE INSTITUTION'S RISK MANAGEMENT PROGRAM. THE COMMITTEE SHALL BE COMPOSED OF AT LEAST THREE (3) MEMBERS OF THE BOARD OF DIRECTORS who SHALL POSSESS A RANGE OF EXPERTISE AS WELL AS ADEQUATE KNOWLEDGE OF THE INSTITUTION’S RISK EXPOSURES TO BE ABLE TO DEVELOP APPRORPIATE STRATEGIES FOR PREVENTING LOSSES AND MINIMIZING THE IMPACT OF LOSSES WHEN THEY OCCUR. IT SHALL OVERSEE THE SYSTEM OF LIMITS TO DISCRETIONARY AUTHORITY THAT THE BOARD DELEGATES TO MANAGEMENT, ENSURE THAT THE SYSTEM REMAINS EFFECTIVE, THAT THE LIMITS ARE OBSERVED AND THAT IMMEDIATE CORRECTIVE ACTIONS ARE TAKEN WHENEVER LIMITS ARE BREACHED.

THE RISK MANAGEMENT COMMITTEE SHALL HAVE A WRITTEN CHARTER THAT DEFINES THE DUTIES AND RESPONSIBILITIES OF ITS MEMBERS. THE CHARTER SHALL BE APPROVED BY THE BOARD OF DIRECTORS AND REVIEWED AND REFINED PERIODICALLY.

THE CORE RESPONSIBILITY OF THE RISK MANAGEMENT COMMITTEE ARE:

IDENTIFY AND EVALUATE EXPOSURES - THE COMMITTEE SHALL ASSESS THE PROBABILITY OF EACH RISK BECOMING REALITY AND SHALL ESTIMATE ITS POSSIBLE EFFECT AND COST. PRIORITY AREAS OF CONCERN ARE THOSE RISKS THAT ARE THE MOST LIKELY TO OCCUR AND ARE COSTLY WHEN THEY HAPPEN.

DEVELOP RISK MANAGEMENT STRATEGIES - THE RISK MANAGEMENT COMMITTEE SHALL DEVELOP A WRITTEN PLAN DEFINING THE STRATEGIES FOR MANAGING AND CONTROLLING THE

MAJOR RISKS. IT SHALL IDENTIFY PRACTICAL STRATEGIES TO REDUCE THE CHANCE OF HARM AND FAILURE OR MINIMIZE LOSSES IF THE RISK BECOMES REAL.

IMPLEMENT THE RISK MANAGEMENT PLAN- THE RISK MANAGEMENT COMMITTEE SHALL COMMUNICATE THE RISK MANAGEMENT PLAN AND LOSS CONTROL PROCEDURES TO AFFECTED PARTIES. THE COMMITTEE SHALL CONDUCT REGULAR DISCUSSIONS ON THE INSTITUTION'S CURRENT RISK EXPOSURE BASED ON REGULAR MANAGEMENT REPORTS AND DIRECT CONCERNED UNITS OR OFFICES ON HOW TO REDUCE THESE RISKS.

REVIEW AND REVISE THE PLAN AS NEEDED - THE COMMITTEE SHALL EVALUATE THE RISK MANAGEMENT PLAN TO ENSURE ITS CONTINUED RELEVANCY, COMPREHENSIVENESS, AND EFFECTIVENESS. IT SHALL REVISIT STRATEGIES, LOOK FOR EMERGING OR CHANGING EXPOSURES, AND STAY ABREAST OF DEVELOPMENTS THAT AFFECT THE LIKELIHOOD OF HARM OR LOSS. THE COMMITTEE SHALL REPORT REGULARLY TO THE BOARD OF DIRECTORS THE ENTITY'S OVER-ALL RISK EXPOSURE, ACTIONS TAKEN TO REDUCE THE RISKS, AND RECOMMEND FURTHER ACTION OR PLANS AS NECESSARY".

This Circular shall take effect on 01 January 2005.

FOR THE MONETARY BOARD:

ARMANDO L. SURATOS Officer-in-Charge

III. Test of Control and Substantive Test of Banks

A. Internal Control Questionnaire

Client:________________________________________________________ Audit Date:______________Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________Reviewed By:__________________________________________________ Date Reviewed: _________Type of Testing: Compliance Cycle: Class of Transaction: LOANS

Questions AnswersYES NO NA REMARKS

1. Are the four functions (loan approval, disbursement, collection, and posting) performed by different employees? 2. Are new payment books mailed to borrowers by employees who perform none of the functions referred to above? 3. Is there proper segregation of duties regarding the recording, collecting and collateral custody functions? 4. Are the department's file cabinets under dual control? If not, are the they locked and fireproof? 5. Is dual control maintained over negotiable collateral? 6. Is a log maintained documenting the access to the negotiable collateral 7. Are customers required to acknowledge receipt of released collateral in writing? 8. Do loan officers initial notes or applications to establish responsibility for the approval of loans? 9. Are the notes and supporting documentation rechecked for completeness by someone other that the officer approving the loan? 10. Are disbursements of loan proceeds made only by official check or a credit to the customers account? 11. Are periodic valuations (i.e. repricing and margining) performed for loans secured by stocks, bonds, CD's, and passbooks? If so, how often is this process performed? 12. Is there documentation to support this procedure? 13. Is there a procedure in place to ensure the insurance for expired policies is renewed? 14. Is the bank protected by an auto single interest policy in cases where insurance has expired or been canceled on automobiles pledged as collateral?

15. When life insurance and/or credit disability insurance coverage is refused by the insurance company is premium plus appropriate finance charge on the premium refunded to the customer? 16. On loans paid off by check, does the bank hold the loan papers until it is assured the check has cleared? 17. Are all correcting entries supported by properly authorized debit and credit tickets? 18. Is a reconciliation of principal and interest balances on the trial balance for all departmental general ledger and DDA accounts performed at least monthly? 19. Are all reconciling items adequately explained and dated? 20. Are procedures in place which provide effective follow up for missing or incomplete documentation? 21. Missing collateral? 22. Are there adequate controls to insure that customers whose loans have been charged off are not extended credit again? 23. Is it possible for a customer to overdraw against their home equity or reserve checking lines of credit? 24. Are tellers instructed to review the payment coupon to determine if the customer is past due and, if so, collect the late charge at that time? 25. Is a follow up procedure for collections in effect? 26. Are past due loans listed at least monthly and reviewed by directors and/or officers? 27. Is there a procedure in place that would preclude a loan officer from charging off a loan the officer approved? 28. Do late charge waivers require an officer's approval?

Client:________________________________________________________ Audit Date:______________Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________

Reviewed By:__________________________________________________ Date Reviewed: _________Type of Testing: Compliance

Cycle: Class of Transaction: INTEREST INCOME

Questions Answers

YESNO NA REMARKS

1. Are the advertisements accurate and representative of the bank’s deposit contracts offered? 2. Are interest rates, if stated< stated in terms of annual percentage rate of simple interest? 3. Are time and amount requirements that are necessary to obtain the stated rates clear and conspicuous? 4. Is a notice concerning the penalties for early withdrawal stated clearly and conspicuously? A. Is it in writing and furnished prior to entering into a time deposit? 5. Is the term “profit” used in the advertisement? 6. Do the advertisements for deposits state that the bank is a member of the FDIC? 7. Does the bank solicit deposits subject to interest rate ceilings by offering premiums in the form of merchandise, credit or cash? 8. If the bank uses “in-house” developed advertising for deposits, are the advertisements reviewed prior to publication? A. Does a qualified individual review them for compliance with regulatory requirements for advertising? 9. Are the official FDIC signs posted at each teller window and other locations within the bank where deposits are received?

Client:________________________________________________________ Audit Date:______________Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________

Reviewed By:__________________________________________________ Date Reviewed: _________Type of Testing: Compliance

Cycle: Class of Transaction: INTEREST EXPENSE

Questions Answers

YES NO NA REMARKS

1. Is the interest expense general ledger reconciled on a daily basis by designated employee? 2. Is the reconciliation of interest expense general ledger account reviewed by supervisory personnel? 3. Is any out of balance condition identified and resolved in a timely manner? 4. Is designated employee responsible for the reconciliation of the interest general ledger not involved in the issuing or redemption of accounts?

Client:________________________________________________________ Audit Date:______________

Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________

Reviewed By:__________________________________________________Date Reviewed: _________

Type of Testing: Compliance

Cycle: Class of Transaction: INVESTMENT SECURITIES

Questions Answers YES NO NA REMARKS

1. Are responsibilities for initiating, evaluating, and approving transactions adequately segregated from those for detail accounting, general ledger, and other related functions? 2. Are responsibilities for initiating transactions adequately segregated from those for final approvals committing state resources? 3. Are responsibilities for monitoring investment market values and performance adequately segregated from those for investment acquisition? 4. Are responsibilities for maintaining detail accounting records adequately segregated from those for general ledger entries? 5. Are custodial responsibilities for securities or other documents evidencing ownership or other rights assigned to an official with no accounting duties? 6. Do approval procedures include the following? a.If applicable, procedures adequate to ensure only investments permitted by law are acquired? b.Formal establishment and periodic review of investment policy guidelines?

c.Integration of the investment program with the cash management program and with expenditure requirements? d. Established authority and responsibility for investment-opportunity evaluation and purchase? e.Periodic evaluation of the performance of the investment portfolio by persons independent of investment portfolio management activities? f. Do detail accounting procedures include the following? 7. Do detail accounting procedures include the following? a. Maintenance of detail accounting records for investments? b. Procedures to ensure transactions arising from investments are properly processed, including income and amortization entries, if applicable? c. Controls to ensure investment earnings are credited to the fund from which resources for the investment were provided? d. A periodic comparison between income received and the amount specified by the terms of the security, or from publicly available investment information?

Client:________________________________________________________Audit Date:______________

Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________Reviewed By:__________________________________________________ Date Reviewed: _________Type of Testing: Compliance

Cycle: Class of Transaction: DEPOSITS

Questions Answers YES NO NA REMARKS

1. Are demand deposit personnel prohibited from acting as relief tellers? 2. Are deposit tickets and cancelled checks filed in locking cabinets or vaults not accessible to tellers? 3. Is a daily listing of closed accounts prepared and submitted to bank management? 4. Are listings mentioned in no. 3 above checked for zero balances by someone other than tellers or deposit services personnel? 5. Are statements of closed accounts mailed to depositors immediately following the account closing by someone other than a teller or deposit services employee? 6. Are statements mailed or delivered to depositors

monthly with the exception of depositors who have requested that their statements be received over the counter? 7. Are over the counter statements delivered to someone other than a deposit services employee or teller for control and handling? 8. Is written authorization on file from customers who want their statements held for pickup at the bank? 9. Are customers required to sign for statements when picking them up? 10. Are all not picked up over the counter statements mailed at least once each quarter? 11. Are employee deposit accounts properly identified and reviewed periodically by an officer for unusual activity? 12. Are inactive accounts properly identified? 13. Are checking accounts reviewed regularly for the purpose of transferring accounts that have become inactive? 14. Are new accounts opened by employees who are not tellers or deposit services personnel? 15. Is a daily list of new accounts produced and signature cards reviewed and approved in writing by an officer? 16. Are there proper procedures in effect for stop payment orders received? 17. Is a daily overdraft report generated? 18. Are checks and return items promptly charged to the respective accounts? 19. Is there a system in place for follow up on unpaid overdrafts? 20. Are deposit system records being reconciled to the ledger control accounts on a daily or monthly basis? 21. Is the reserve supply or inventory of blank passbooks kept under dual control? 22. Is there a numbering scheme utilized by all branches for new deposits of all types?

Client:________________________________________________________ Audit Date:______________Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________Reviewed By:__________________________________________________ Date Reviewed: _________

Type of Testing: Compliance

Cycle: Class of Transaction: INTERBANK LOANS

Questions Answers

YES NO

NA REMARKS

1. Has the bank developed written policies and procedures to evaluate and control exposure to all correspondents? 2. Have the written policies and procedures been reviewed and approved annually by the board of directors? 3. Do the written policies and procedures adequately address the bank’s exposure(s) to a correspondent including: a.Credit risk? b.Liquidity risk? c.Settlement risk? (See the Introduction) 4. Has the bank evaluated its intraday exposure adequately? 5. Does it have significant exposure to its correspondent because of operational risks, such as extensive reliance on a correspondent for data processing? 6. If so, has the bank addressed those risks (may be elsewhere in its operational procedures)? 7. Do the written policies and procedures establish criteria for selecting a correspondent or terminating that relationship? 8. Do the written policies and procedures require a periodic review of the financial condition of a correspondent whenever the size and maturity of exposure is considered significant relative to its financial condition? (See the Introduction) 9. When exposure is considered significant, is the correspondent’s financial condition reviewed periodically? 10. Does the periodic review of the correspondent’s financial condition include its level of: a.Capital? b.Nonaccrual and past due loans and leases? c.Earnings? d.Other relative factors? 11. If a party other than bank management conducts the financial analysis of or selects a correspondent, has the bank’s board of directors reviewed and approved the general assessment or selection criteria used by that party? 12. If the financial condition of the correspondent, or the form or maturity of exposure creates significant risk, do the written policies and procedures establish internal limits or other procedures, such as monitoring to control exposure? 13. Are the internal limits or controls described in question 11 appropriate for the level of risk exposure? 14. If no internal limits have been established, is this appropriate based on the

financial condition of the correspondent and size, form, and maturity of exposure, and, if so, why not?15. When a bank has set internal limits for significant exposure to a correspondent, has it established procedures or structured transactions with the correspondent to ensure that the exposure ordinarily remains within those limits? 16. If not, is actual exposure to a correspondent monitored to ensure that it ordinarily remains within the bank’s established internal limits? 17. Are transactions and/or monitoring reports on exposure reviewed for compliance with internal policies and procedures? If so, by whom and how often? 18. Are these policies and procedures for deterioration appropriate and realistic?

Client:________________________________________________________ Audit Date:______________Client Personnel Interview:__________________________________________________________________Auditor:_______________________________________________________ Date Completed:_________Reviewed By:__________________________________________________ Date Reviewed: _________Type of Testing: Compliance

Cycle: Class of Transaction: DUE FROM BANKS

Questions Answers

YESNO NA REMARKS

1.The association receives bank statements: a. Daily? b. Monthly? c. Quarterly? 2. Does the association reconcile bank accounts on a regular and timely basis? How often? 3. Are there any unreconciled bank accounts? If so, which accounts? 4.Are there are any out of balance accounts? If so, which accounts? 5.Is the person who reconciles the bank statements independent of the deposit and check writing process? 6.Do checks drawn on bank accounts need more than one sig- nature? If so, is this required only for checks above a predetermined amount? 7.Does a person who does not have signature authority periodically reconcile unsigned checks to the shipping invoice? How often?

B. AUDIT PROGRAMS

Bank of the Philippine IslandsLOANS

December 31, 2006

AUDIT PROCEDURESAssertions

WP /

REF DONE BY DATE1. Using the loan trial balance, select a sample of loans that were opened since the prior audit date. The sample should encompass all types of loans including autos, boats, mobile homes, unsecured loans, recreational vehicles, motorcycles, stocks & bonds, single payment, etc. E 2. For each loan selected, perform the following:

A. The application should be completed and signed by the borrower. The purpose of the loan should be clearly stated. C

B. Determine the security agreement, note, and disclosure statement have been properly signed and dated by the borrower. Compare the description of the secured property to the title.

PP/D

C. Determine the approving officer did not exceed his

lending limit when approving the loan.V

V/A D. Determine how the loan proceeds were disbursed to the customer. Trace the transaction. E

E. If the loan was made to a business, determine the proper resolutions or agreements are on file. Note and investigate any discrepancies between the note and the resolution.

/V/A

F. Determine that loans were approved before the loans

was closed and the funds were disbursed.V

V/A G. Determine if the bank is listed as the first lien holder to the secured property. R/O H. Determine if the title has been recorded with the proper government agency. P/D

I. Compare the description of the secured property to the security agreement for accuracy.

V/A

J. Determine the insurance policy is current and coverage is adequate. R/O

K. Compare the description of the secured property to the security agreement for accuracy. R/O L. Verify the UCC-1 was filed. C M. Determine if it was properly signed and dated by the borrower. C

N. Compare the description of the secured property to the security agreement for accuracy.

V/A

3. Mail positive confirmations on all loans selected in the review (not to exceed 25). Confirm the collateral, principal outstanding, rate, payment, and term as of the month-end date. R/O 4. Prepare a confirmation control listing workpaper summarizing all relevant information. Explain any discrepancies noted in the information confirmed. V/A 5. Determine the following documentation was included in the file and that it had been properly completed: C Application Note Credit report Verification of income Verification of employment Copy of insurance policy listing bank as lienholder for any collateral Collateral (i.e. title to auto)

Regulation Z disclosures (if applicable) P/D Right of rescission disclosures (if applicable) P/D Flood search (if applicable) P/D Determine that the application was dated and initialed by the approving officer. C Determine the borrowers indicated on the note whether or not they request credit life insurance.

RR/O

Determine the collateral being held agrees with the collateral listed on the note. V/A 6. Select a sample of paid off loans. Request a history report. Recalculate the payoff amount and trace to the G/L for proper posting. E

7. Investigate any waived fees for authorization. This includes late fees, extension fees, etc.

C

8. Examine trial balance for accounts with excessive numbers of extensions and investigate. V/A 9. Inquire as to who accepts and processes consumer loan payments. E

10. Trace a sample of payments to ensure they are credited to the correct account and posted timely. E 11. Obtain a copy of the past due report. Review the status of accounts over 90 days past due with the loan officer. V/A 12. Document the collection procedures and verify the appropriate collection efforts are being made. Verify that letters are mailed at required intervals. E 13. Investigate any unusual trends in past dues and any concentration of past dues by any one officer. E 14. Investigate any debits to income over $100 and any other unusual items for authenticity. V/A

15. Select a sample of charged-off accounts and determine whether proper approval was obtained for the charge-off. C

16. Ascertain that collection efforts are in effect until declared totally uncollectible by management. C 17. List and review all non-accrual accounts. V/A A. List reason, review with appropriate lending officer to determine collection efforts, and verify authorization for non-accrual status. P/D B. Ensure that these are properly reported to the Board of Directors and Loan Committee. P/D

18. Select accounts that have been placed back on accrual and determine compliance with bank policy and applicable regulations. R/O 19. Examine selected recent payments on non-accrual accounts and determine appropriateness of entry to recognize interest or reduce principal. P/D 20. Obtain a listing of changes made (monetary and non-monetary) and verify proper approval. C

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsINTERESTS

December 31, 2006

AUDIT OBJECTIVE:

OOversight and Organization Structure: Determine the extent and effectiveness of senior management and board

supervision of the bank’s interest rate risk activities and review the following: Bank’s objectives, strategies, and risk tolerance for interest rate risk. Instruments and portfolios used by the bank to manage its interest rate risk

exposure. Individuals or units responsible for measuring, managing, and controlling the bank’s interest rate risk.

SCOPE: Discussions with management and review corresponding documentation.

AUDIT PROCEDURES

Assertions

WP /

REF DONE

BY

DATE

Loan Portfolios:

Discuss with management the policies regarding loan pricing and maturities and the development of new loan products or structures.

E

• Are there sufficient controls in place to monitor and control the taking of interest rate positions through the bank’s loan activities. V/A Determine how management uses assumptions and methods to assess the effective maturities or repricing dates for loans with unspecified maturities (Credit Card Loans). P/D • Does the bank have a large volume of these types of loans or does it plan to within the next 6 to 12 months? V/A Determine if the bank has substantial volumes of medium or long-term fixed rate loans. C

• How does the bank monitor and evaluate the actual or potential appreciation or depreciation in those portfolios.

V/A

• Does management assess how appreciation or depreciation could affect the bank’s earnings and capital.

V/A

Determine the volume and $$ value of mortgage products and other loans with explicit caps relative to the balance sheet. V/A • How does the bank monitor and evaluate the effect of those caps on the bank’s future earnings. C

• What level of interest rates those caps would come into effect. C Determine if the bank periodically assesses how a substantial increase in interest rates may affect the credit performance of its loan portfolio. V/A Does the bank incorporate and enforce prepayment penalties on medium or long-term fixed rate loans. V/A SCOPE: Discussions with management and review corresponding documentation. Investment Portfolios: Obtain a current investment trial balance • Review all purchases and sales since DATE. E,C • Determine the nature and maturity/repricing composition of the bank’s investment portfolio. V/A

Determine the bank’s investment strategies with regard to interest rate risk management. N/A • Are there documented policies/procedures in place outlining the strategies. R/O

• Are the bank’s classification and accounting treatment for its investment holdings appropriate given management’s strategies and actions.

P/D

Determine if the bank has substantial volumes of medium or long-term fixed rate investments. V/A

• How does the bank monitor and evaluate the actual or potential appreciation or depreciation in those investments.

P/D

• Does management assess how appreciation or depreciation could affect the bank’s earnings and capital.

P/D

Determine whether the bank’s interest rate risk measurement systems can adequately evaluate securities with embedded options, such as CMO’s, and structured notes. V/A SCOPE: Discussions with management and investment accounts as of DATE. Deposit Accounts: Determine whether management has analyzed the bank’s deposit base. • Does the analysis consider the bank’s pricing policy as well as how competitors’ actions may affect the bank’s pricing policy. P/D Determine whether management has estimated how the bank’s deposits will

react in different rate environments, including whether management has considered: V/A

• Implicit or explicit floors or ceilings on deposit rates. Determine whether management has analyzed trends in deposit accounts for: • Stability of offering rates. V/A • Increasing or declining balances. V/A • Large depositor concentrations. V/A • Seasonal and cyclical variations in deposit balances. V/A

Determine if management performs sensitivity analysis on deposit assumptions. • Does management analyze how its interest rate exposure may change if those assumptions change or prove to be incorrect and what action, if any, would be taken.

P/D

Determine reasonableness of the bank’s assumptions about the effective maturity of the bank’s deposits. Evaluate to what extent the bank’s deposit base can offset interest rate risk exposures. P/D SCOPE: Discussions with management and investment accounts as of DATE. Management Information Systems: Determine whether the bank’s management information systems (MIS) provide adequate and timely information for assessing the interest rate risk exposure in the bank’s current balance sheet positions. Consider whether information is available for all the bank’s material portfolios, lines of business, and operating units including: E • Current outstanding balances, rates/coupons, and repricing indices. E • Contractual maturities or repricing dates. V/A • Contractual caps or floors on interest rates. P/D • Scheduled amortizations and repayments. V/A • Introductory “teaser” rates. V/A

Determine whether the bank’s method of aggregating data is sufficient for analysis purposes given the nature and scope of the bank’s interest rate risk exposure(s). V/A MORTGAGE TESTING – DETERMINE VALUE OF ASSETS FIRST Determine whether the bank’s MIS provides sufficient historical, trend, and customer information to help bank personnel formulate and evaluate assumptions regarding customer behavior. Consider, where material, whether information is available to analyze: C,E • Loan prepayments. C,E • Early deposit withdrawals. C,E

• Spread between administered rate products, such as prime based loans and non-maturity deposit accounts, and market rates of interest.

C,E

SCOPE: Review supporting documentation and discussion with management. Risk Measurement Systems: Determine the type of interest rate risk measurement systems used by the bank and evaluate the adequacy of those systems. Consider whether the measurement system(s): • Identify and measure the bank’s major sources of interest rate risk exposure. V/A • Are commensurate with the size, nature, and complexity of the bank’s activities. P/D • Provide estimates of the bank’s exposures in a timely and comprehensive manner. P/D

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsINTEREST EXPENSEDecember 31, 2006

AUDIT OBJECTIVES:

To determine whether:

1. Interest expense (including amortization of debt discount and premium) represents all interest incurred during the period and has been properly recorded.

2. Interest expense is properly described and classified and adequate disclosures with respect to these amounts have been made.

AUDIT PROCEDURES:

ProceduresAssertions

WP Ref.

Done

Y/N?

By Date

1) ANALYTICAL PROCEDURES—GENERAL

a. Compare the balance of each significant interest expense account with the comparable balance for the preceding period and with the budgeted balance for the current period. Investigate significant or unusual fluctuations.

EE

b. Predict interest expense for the period by category of borrowing by multiplying the average principal amounts outstanding during the period by the expected average interest rates. Compare the predicted amounts with the recorded amounts and investigate significant differences.

V/A

c. Calculate average effective interest rates for the period by category of borrowing or by type of debt instrument by dividing recorded interest expense by the average principal amounts outstanding during the period. Compare calculated interest rates to expected interest rates based on confirmation with third parties, examination of debt agreements, etc. Investigate significant differences.

V/A

2) DETAIL TESTS OF INTEREST EXPENSE

a. Have the client prepare a schedule of interest payments by debt instrument. Verify the clerical accuracy of the schedule and test it as follows:

C

1. Determine whether the detail agrees in total to the recorded interest expense for the period. Investigate significant or unusual reconciling items.

2. Review the nature of the amounts included in interest expense for propriety.

3. Examine ( ) critical forms and documents to verify the amounts. Scope:( )

4. Cross-reference accrued interest payable at the end of the period to our testing of accrued interest payable.

3) ANSWER INTERNAL CONTROL QUESTIONNAIRES

V/A

P/D

E

E

4) SUPERVISION, REVIEW AND CONCLUSIONS

a) Conclude responsive to the audit objectives.

N/A

b) Prepare points regarding internal controls and other business matters.

N/A

c) Perform senior review and supervision.

d) Clear senior review points.

N/A

N/A

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsINVESTMENT SECURITIES

December 31, 2006

I. OBJECTIVES

1. To determine if policies, procedures, practices, and internal controls regarding investments are adequate; that officers/employees are operating in accordance with established guidelines.

2. To ensure transactions are properly authorized, recorded, and executed at current market prices; that securities, as recorded, are on hand or in possession of custodians

for the bank's account.

3. To determine that subsidiary records are reconciled on a regular basis and are in agreement with G/L control accounts.

4. To determine that accrual of income, amortization of premiums, and accretion of discounts are appropriate and accurate.

5. To determine compliance with laws, rulings, and regulations.

AUDIT PROCEDURESAssertions

WP /

REF DONE

BYDATE

Balancing 1. Obtain subsystem reports and reconcilements for all investment accounts, related income/expense accounts, and any suspense/clearing accounts, as of our audit date; P/D Foot reconcilements and verify mathematical accuracy; V/A E

Trace subsystem totals from reconcilement to supporting subsystem reports; E Trace G/L totals from the reconcilement to the Daily Balance Sheet; E Trace all reconciling items to clearance and investigate any old and unusual items. P/D 2.Determine the bank's subscription of Federal Reserve Stock equals 6% of the bank's capital and surplus, of which, 3% must be paid in. P/D Recalculate dividend income and trace to G/L. V/A Confirmations 3.Prepare and mail confirmation requests for securities held in safekeeping by E correspondent banks and other custodians, as of audit date; Compare securities safekeeping lists received from the correspondents/agents to the bank's securities inventory report; E Determine pledge status is properly noted; V/A Investigate and clear all exceptions; V/A Send second requests to safekeeping agents from whom no reply was received. V/A 4.Examine/count any securities on hand and compare details to the securities inventory report C Account for all bond coupons, if any; E Investigate any discrepancies. V/A Tests of Security Transactions 5.Select a sample of investments purchased, since the previous audit, and perform the following: E Verify cost by examining invoices/advices; E Trace purchases to entries in the G/L; E

Trace purchase transactions to approval in the Investment Committee or BOD minutes.

E

6. For securities sold, verify that gains or losses were accurately computed and recorded;

V/A

Verify sales price by examining invoices and broker's advices; V/A Check computation of book value on settlement date; V/A

Calculate gain or loss and trace to G/L; V/A Verify G/L has been properly relieved of the investment, accrued interest, premium, discount, and any other related accounts; V/A Trace sales transactions to approval in the Investment Committee or BOD minutes. E Premium Amortization/Discount Accretion 7. For investments purchased at a premium or discount, since the previous audit, select a V/A sample and test book value, by performing the following:

Determine method used to calculate and record amortization of premiums and accretion of discounts; and V/A Determine the gross amount of premium or discount at purchase date; P/D Determine period to maturity or call date; C

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsDEPOSITS

December 31, 2006I. OBJECTIVES

1. To determine if policies, procedures, practices, and internal controls regarding deposit accounts are adequate; that officers/employees are operating in conformance with established guidelines.

2. To ensure that all deposit transactions are processed and properly recorded.

3. To determine that returned items and posting rejects are properly and timely processed.

4. To ensure that service charges/fees due for services and penalties rendered are properly assessed and recorded.

5. To determine overdrafts are processed properly and in accordance with established bank policies.

6. To determine required documentation is obtained prior to opening of deposit accounts; that closed accounts are properly and timely closed.

7. To determine that dormant account transactions are bona fide, properly authorized, and that controls are adequate to prevent unauthorized access to dormant accounts.

8. To determine that subsidiary records are reconciled on a regular basis and are in agreement with G/L control accounts; that any outstanding items are properly researched and resolved in accordance with policy and procedures.

9. To determine that adequate separation of duties exists in entry-making and reconcilement functions.

10. To determine that any clearing/suspense accounts used in the deposits processing function are for legitimate purposes.

11. To ensure that accrued interest is properly computed and recorded

AUDIT PROCEDURESAssertions

WP /

REF DONE

BY DATE

Balancing 1.Obtain G/L Daily Balance Sheet, Demand Control Summary Bank Totals Report, and reconcilements for all Demand accounts, as of audit date, including reconcilements of any DDA related suspense, Deposit and related accrued interest payable liability unposteds, and clearing accounts, and: E Foot reconcilements and verify mathematical accuracy; V/A Trace system (subledger) totals from reconcilement to supporting subledger report;

E Trace G/L totals from the reconcilement to the Daily Balance Sheet; E

Trace all reconciling items to clearance and investigate any old and unusual items.

E

Confirmations 2. Using appropriate sampling technique, prepare confirmations on selected accounts; and V/A Send second requests to customers from whom replies were not received to the initial positive confirmation requests (10 days); P/D Investigate and clear all exceptions; V/A Summarize confirmation results; P/D Where replies were not received to positive requests for confirmation, perform alternative procedures, i.e., comparing customer's signature on the checks to the signature card.

C,P/D

Accrued Interest Payable Recalculation 3. Run query of interest bearing accounts, whose statements cycle on our test date, from all account types on the system. Select a sample and perform the following:

E

Obtain and use copies of statements/account histories for each account in our sample to perform testwork;

E

Recalculate accrued interest payable; V/A Run report comparing interest paid on customer account with interest expense posted to general ledger. C Document and research any differences. C Interest Expense Reasonableness Test 4.From FCNB rates Billboard, or other appropriate documentation, determine number of rate changes YTD for each interest bearing account type and perform the following: P/D Compute the average rate YTD and multiply that rate by the average outstanding deposits in each category for an estimate of anticipated interest expense; V/A Compare this amount to the actual balances and compute the difference; V/A Conclude as to reasonableness of expense account balances, as of our audit date.

C,P/D

Analytical Review

5. Prepare a schedule and analyze changes in Demand Deposit balance sheet and related income and expense accounts, for reasonableness;

V/A

Compare current balances, as of our audit date, to prior year balances; C

Compute differences and document reasons for significant variances from prior year. C

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsINTERBANK LOANS

December 31, 2006

AUDIT PROCEDURESAssertions

WP /

REF DONE BY DATE

A. GENERAL 1. Review Prior Year Work papers. V/A

2. Review audit program and banking regulations. R/O 3. Review the bank’s loan policy manual. The loan policy should R/O include: a. Target Market. V/A b. Loan portfolio diversification standards. V/A c. Acceptable collateral types. V/A d. Maximum loan maturity by type of property. V/A

e. Loan-to-value limits by type of property and minimum equity

V/A

for construction projects.

f. Financial information requirements by type of loan.V/A

g. Loan origination and approval procedures. V/A h. Review and approval procedures for exception loans. R/O i. Administration procedures: documentation, disbursement, P/D collateral, inspection, collection and loan review. j. Real estate appraisal and evaluation guidelines. V/A k. Reporting requirements to the Board. P/D l. Prohibits commissions or gifts to loan officers for procuring loans. R/O

m. Prohibits preferential credit to insiders and insiders of correspondent banks

R/O

4. Identify primary G/L accounts involved in this cycle. V/A Analyze in relation to prior year. Consider the need to Apply other procedures.

5. Note whether the loan portfolio diversification guidelines of R/O the policy have been exceeded. 6. Review the Board of Director Minutes. V/A 7. Review all loan-related committee meeting minutes for the past V/A Year. Note any information that could affect the scope or timing of fieldwork. 8. Review the Federal Commercial Bank Exam Report. V/A

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Bank of the Philippine IslandsDUE FROM BANKSDecember 31, 2006

I. OBJECTIVES

1. To determine if policies, practices, procedures, and internal controls regarding Due From Banks are adequate; that officers and employees are operating in conformance with the established guidelines.

2. To determine that all "due from" accounts are reasonably stated and represent funds on deposit with other banks; that transactions are properly authorized and completed on a timely basis.

3. To assure timely reconciliation of the due from bank accounts.

4. To assure compliance with charge-off policies for aged reconciling items; that proper research and clearance is performed.

AUDIT PROCEDURESAssertions

WP /

REF DONE

BY DATEBalancing 1. Obtain Daily Balance Sheet, copies of correspon¬dent bank statements, and reconcilements for all Due From Bank accounts, as of our audit date; E Foot reconcilements and verify mathematical accuracy; E

Trace system (subledger) totals from reconcilement to supporting subledger report; E Trace G/L totals from the reconcilement to the Daily Balance Sheet; E

Trace all reconciling items to clearance and investigate any old and unusual E items (Obtain and use copies of subsequent bank statements);

For aged reconciling items, if any, obtain explanations for items that have been open an unreasonable length of time, i.e., over 2 months, and evaluate follow-up action taken to resolve open items for adequacy;

N/A

Document reconciling items that are exceptions to charge-off policies and obtain management's reason for waiver.

E

Confirmations

2. Just prior to audit date, contact Controller Department and request that statements for Due To Bank accounts be held for our attention. Prepare positive confirmation requests and enclose with the statements.

C

3. Also, just prior to audit date, prepare and send Confirmation requests to Due From correspondent banks requesting cut-off statements and/or balance to our credit, as of our audit date; C Check replies to confirmation requests. Investigate and clear any exceptions;

Send second request to banks who have not replied to initial requests. Other 4. Obtain copies of the bank's reports of its Federal Reserve requirements, for the 4 week period prior to audit date, and verify that reports are accurate and complete. R/O

5. Review items and supporting documentation making up The Treasury Tax and Loan account for propri¬ety and timely clearance.

R/O

PERFORMED BY: REVIEWED BY:

Audit Assistant Audit Supervisor

Assertions Initials

C = Completeness

E = Existence

R/O = Rights and Obligations

V/A = Valuation and Allocation

P/D = Presentation and DIsclosure

Conclusion:

Base on our review of the financial statements of the Bank of the Philippine Island audited by the famous Isla Lipana. In our opinion we believed the audited fianacial statements of BPI accompaniying notes to financial Statements presented fairly contains necessary and required information that is relevant and in accordance with the Philipppine Financial Reporting Standard (PFRS) and in compliance with the regulatory authorities such as compliance with BSP Banko Sentral ng Pilipinas.