Departmental Auditor would be looking forward to these things while Scrutiny of Financial Statements (Happy GST series – 32) by CA Rajender Arora
Departmental Auditor would be looking forward to these things while Scrutiny of Financial
Statements during audit.
I. Scrutiny of Financial Statements
1) Director’s Report: - This gives information like overall financial results of the company,
important happenings during the year and future plans of the company. Some of the
important happenings like fire and loss of material in the company, details of new products
launched, change in the marketing pattern etc. reported in the report may be useful to the
auditor.
Director’s report may, inter alia, contain information about
a) Foreign Exchange earned during the year.
b) Foreign Exchange paid during the year, e.g. may be on account of taxable services
provided by the registered person/Taxpayer where he is liable to pay GST under reverse
charge mechanism.
c) Information on the operations carried out by the registered person/Tax payer during
the year under report. This may help in finding the exact nature of services provided by
the registered person/Tax payer.
d) The facts stated in Director’s Report should be reconciled with the GST Returns.
2) Auditor’s Report: - These may be reports of statutory auditor or internal auditor or C & AG
Audit. In the case of statutory audit, a separate report under CARO (Companies Auditor’s
Report Order, 2003/2015) is required to be given.
a) The Auditor’s Report should be studied to find out any qualified/adverse opinion
given by the auditors which may have impact on GST liability. For example, Auditor
may report that goods meant for outward supply, available in stock were not reconciled
or provision for obsolete items has not been made during the year. Tax auditor may like
to examine such opinion in detail.
b) Company Auditor’s Report Order (CARO) may be studied to find out whether the fixed
assets records have been maintained properly or whether physical verification of inward
supplies and goods meant for outward supply was undertaken and whether any
discrepancies were noticed on such verification or whether the company has maintained
proper records for unserviceable or damaged goods.
c) CARO also shows disputed tax liabilities separately for Customs, Income Tax, GST etc.
Cases booked under Income Tax may be examined to find out any implication on GST.
d) In the case of Public Sector unit, C & AG report and comment of the company available
in the Annual Report should be examined.
3) Trial Balance: - Trial Balance is a statement showing balances of all accounts in the
ledgers as on a particular date.
The final accounts, namely, Profit & Loss account and Balance Sheet are prepared from the
Trial Balance only. From the Trial Balance, similar accounts are grouped together and these
are transferred to the Profit & Loss Account and Balance Sheet.
Types of verification:-
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a) Familiarization with account coding system and understanding the grouping of
subaccount under main accounts for the purpose of summarization into Profit & Loss
Accounts and Balance Sheet.
b) Main purpose is to select the accounts for further scrutiny as a part of audit plan.
Accounts which have a prima facie relevance for GST payment or availment of ITC need
to be identified.
c) Unusual ledger accounts like Loss of inputs or unusual income accounts may also be
noticed in the Trial Balance. However, such accounts will not be reflected in the Profit &
Loss Accounts as these accounts are adjusted against other accounts. Such account
may be selected for finding of exact nature and detailed scrutiny.
d) Various income accounts (credit balances) available in the Trial Balance like Job Work
Income Account, Erection and Commissioning Income Account, Commission Account,
Recovery of Freight/Advertisement Charges Account Technical Consultation Income
Account etc. should be selected to verify whether these income can be added to the
assessable value for payment of GST or whether these are liable for payment of GST.
4) Cost Audit Report: - Cost Audit Report provides quantitative and financial details regarding
production, clearance, capacity utilization, input-output ratio, related party transaction,
valuation of production along with reconciliation of annual turnover with taxable value of
Goods produced as per the GST returns.
The Cost Auditor in his report gives the information/details on the cost data for the company
as a whole as well as in the respect of each plant/unit of the company located at different
locations, thus study of the report helps the audit officer in comparison of various
information/details across the plants and units.
In case Registered person is not covered under the cost audit, the Audit Officer may
examine the Cost Accounting records maintained by them on the lines of Cost Audit Report.
5) Profit and Loss Account: - The Profit and Loss Account shows major items of expenditure
and income. In the main body of the Profit & Loss Account, only major heads of expenditure
and income are given and the constituents of these headings are given in a separate
annexure. The said annexure should be studied in detail.
Types of verification:
a) Scrutiny of supplies: Supplies may include inter-state supplies, intra-state supplies, Zero
rated supplies including supplies to SEZ. Study of the pattern of supplies will give an
idea about the volume of indigenous/ internal market for the registered person’s
supplies.
b) Other incomes like scrap, insurance claims receipt, profit on sale of fixed assets,
commission received, erection and commissioning, freight and insurance recovered etc.
may be examined in detail to find out the exact nature of such incomes and whether
these have any bearing on the valuation or whether these are liable for GST
c) On the expenditure side, value of inward supplies on which GST is payable under
Reverse Charge - Section 9(3) should be examined in detail. For this purpose, the
relevant ledger account may be scrutinized as discussed under the head General
Ledger. Ratios like
i. Inputs consumed to inputs purchased,
ii. ITC availed on inputs to outward supplies, raw material purchased and ITC taken
on inputs etc. may be worked out.
d) Notes given along with the said schedule should be studied carefully to find out cases of
use of material for non-production activities.
e) The expenditure or income of the major heads should be compared with the previous
year’s amount in order to find out cases of major variations.
6) Balance Sheet: - Balance sheet is a statement of assets and liabilities of a unit on a
particular day. The overall financial health of a company can be determined from the study
of a Balance sheet.
Types of verification
a) Study of schedule of Share Capital may reveal if the company is subsidiary company
and in case the company is holding company, in that case, the name of subsidiary
company will be disclosed in the Schedule of Investment.
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If there are supplies between holding company and subsidiary & vice versa, valuation
aspects needs to be examined in the light of CGST Rules.
b) Study of fixed assets schedule may show additions and deductions to the fixed assets
during the year. For the deductions made during the year, verification may be made as
to whether appropriate GST has been paid.
7) Notes to the Accounts: - These notes are part of the Profit & Loss Account and
Balance Sheet.
These notes may be inserted by the company as per the requirement of the Companies Act
or may be added at the instance of Statutory auditor. These notes are very important to a
Tax auditor as these reveal important transactions or the important accounting policies
followed by the unit.
In case of debtors, notes indicate debtors which are outstanding for a period exceeding 6
months.
Foreign Exchange related transactions are also given in the notes on accounts.
Management can use these figures to show book profit to suit their requirements.
Netting of amounts of revenue or expenditure can also be resorted to by the management
although as per accounting standards it is mandatory to specify the figures separately.
Scrutiny of Notes will also reveal as to whether there was any change in the system of
accounting. For example- a Taxable person changes from cash system of accounting to
mercantile system.
The notes also indicate the impact of accounting policies on various liabilities including the
tax liability of the Taxable person. Therefore, the auditor must read the notes carefully.
8) Scrutiny of Tax Deducted at Source (Income Tax TDS) Certificates: - The total receipts
can be verified from TDS certificates in the following manner:-
i. By deducting the amount of GST from the value on which tax has been deducted at
source, the receipts appearing in the books of accounts can be reconciled.
ii. The nature of supplies can also be confirmed from these certificates and in case of any
discrepancy in the categorization of services under proper head, elaborate checks need
to be carried out by the Auditor.
iii. Details of TDS credit claimed in the Income Tax Return may also be examined.
9) Tax Audit Report: - The Tax Audit Report is given by Chartered Accountant. The said
report is given in the form 3 CD and it is required to be enclosed along with the Income tax
return filed by the assessee.
Scrutiny of the Tax Audit Report
i. Clause 18 of the Tax Audit Report provides information about amount of depreciation
under Section 32 of the Income Tax Act, 1961 and that of ITC availed on capital goods.
Depreciation statement as per the provisions of Income Tax Act enclosed with Tax Audit
Report may be verified to confirm the correctness of availment of ITC on capital goods.
ii. Clause 27(a) of the Tax Audit report gives the details of ITC claimed. It also provides the
details of credit available and carried forward to the next year. Hence, the Auditor can
authenticate the amount of credit carried forward in the GST returns with the information
provided in terms of this clause.
iii. Clause 21(b) of the Tax Audit Report also gives information regarding prior period
incomes and expenses booked in the year under Tax audit. The Auditor shall ensure
that GST on such supplies is paid on these amounts as per the provisions of Time of
supply under CGST Act.
iv. Clause 38 of the Tax Audit Report provides the information relating to Cost Audit. If such
an audit has been carried out, the Auditor should examine the Cost Audit Report.
v. Clause 40 of the Tax Audit Report provides the important accounting ratios.
vi. As per clause 35(a) to 35(c), details like opening stock, purchases, sales and closing
stock of trading activities and in the case of manufacturing unit quantitative details or
principal items of raw materials, finished goods and byproducts showing opening stock,
purchases, consumption, sales, closing stock, yield of finished goods, percentage of
yield and shortages/excesses is required to be given.
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This information may be used by Tax Auditor to verify the input-output ratio. The reasons
for excessive shortage/ excesses and whether duty has been paid on the sale of raw
material as reported in the tax audit report may be inquired into.
10) Income Tax Returns: - This return is filed by the assessee with the Income Tax department
showing the calculation of income tax on the profit / loss earned by them.
In the computation of income statement, a depreciation statement is also enclosed. The said
depreciation statement shows depreciation claimed on various assets as per the provisions
of Income Tax Act. The auditors should verify whether the value considered for claiming
depreciation is inclusive of ITC availed by the tax payer or not.
11) Ledger: - Ledger is a book where transactions of same nature are grouped together in the
form of an account. For example, all transactions relating to GST payment may be entered
in GST Payment Account.
Ledgers are of three types:
a) Debtor’s Ledger: - This contains accounts of all debtors (customers). All transactions
made with a customer are entered in the individual account of each customer. Details of
sales invoices and debit note issued to a customer and payment received from a
customer are entered in the customer’s individual account.
i. Ledger account of the major customers should be scrutinized. In the Customer’s
account it should be verified as to what are the documents used for recording the
sales of the goods/services. These documents may be sales invoices or debit
notes or Journal Vouchers (JV). If debit note and JVs are also found entered in
the customer’s account, such documents should be verified to find out the
reasons for such recoveries from the customers and whether GST has been paid
or not.
ii. If substantial amount of advances are recovered regularly, this may also be
verified from customer’s account. In such cases, there may be credit balance
showing receipt of advance payment.
b) Creditor’s Ledger: - This Ledger contains accounts of all creditors like suppliers and
service providers. Like in the case of Debtor’s Ledger, in the case of supplier’s account,
the details like purchase invoice, debit note or JV may be available in a supplier’s
account. The debit note or JV might have been prepared for rejection of purchase
material or for short receipt of purchase material or for short receipt of services.
If the customer’s account shows details of debit note or JV, the reasons thereof may be
inquired into and whether ITC has been reversed or not may be verified.
c) General Ledger: - This Ledger contains all accounts of assets, liabilities, incomes and
expenses. Scrutiny of this ledger is very important to a Tax Auditor as the income and
expenditure accounts have direct impact on availment of credit, valuation of finished
goods and payment of GST. The General Ledger may contain 100-500 accounts
depending upon the size of the company.
Therefore, selection of account for scrutiny is an important task for an auditor. For this
purpose, accounts should be selected from the Trial Balance which gives names of all the
accounts maintained by a unit. Some of the general rules which may be kept in mind while
selecting the accounts for scrutiny are given below:
i. Credit entries in expenses account.
ii. Income accounts.
iii. Unusual account.
Types of verification:
i. All the important input purchase/inward supply accounts may be verified in order to
find out whether any rejection of raw material or short receipt of input have taken
place and whether ITC has been reversed or not.
ii. Expenditure accounts where recovery of expenses is possible like Packing and
Forwarding Expenses Account, Advertisement Expenses Account,
Transportation/Freight Charges Account, Sales Expenses Account etc. may be
scrutinized in order to find out any recoveries being made from the customer.
iii. From the Trial Balance, the income accounts (these accounts will have credit
balances) should be selected for scrutiny and the exact nature of such income’s
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accounts should be found out from the study of the documents mentioned in the
relevant ledger accounts. Some of these accounts might have direct impact on the
valuation of finished goods or it may also affect the GST liability.
iv. Unusual accounts as noticed during the study of Trial Balance may also be
scrutinized so as to find out the exact nature of such accounts.
v. The auditor may verify the Plant and Machinery Account to find out the additions
made during the year and the disposal of plant and machinery made during the year.
In the case of disposal, whether the appropriate amount of tax has been paid or not
may be inquired into.
i. As far as verification of claiming of depreciation on capital goods is concerned, the
verification should be made from the Income tax return filed by the assessee or from
the Income Tax Audit Report.
12) Debit Notes: - Debit Note is a statement informing the other party that his account has been
debited for the reasons given in the Debit Note.
The financial impact of a Debit Note is that the addressee is liable to pay the amount
mentioned in the said statement to the person who has issued the Debit Note. In other
words, the person issuing the Debit Note is eligible to receive the amount from the
addressee.
Debit Note may be issued for various reasons like return/short receipt of goods
purchased, increase in the rate/quantity of the outward supply of goods made/services
rendered, recovery of packing charges, warranty charges, after-sales service charges etc.
from a customer. The job worker may raise a Debit Note for value of own material used by
him. The principal may issue a Debit Note to a job worker for the value of scrap generated
during job work process and retained by a job worker
i. Since the numbers of Debit Notes issued by a unit are generally not very large,
therefore all the Debit Notes must be studied by a Tax Auditor.
ii. The Debit Note itself shows the reason for its issue and most of the time the
supporting documents are enclosed with the Debit Note. Therefore, such documents
should be studied in detail.
iii. Cases of additional recoveries from the customer or rejection and short receipt of
inputs are generally noticed in the Debit Note.
13) Credit Note: - it is a statement informing the other person that his account has been
credited for the reasons mentioned in the Credit Note. The financial impact of issue of a
Credit Note is that the addressee is eligible to receive the amount of credit note. Credit Note
may be issued for the reason like return of goods by the customer (sales return) etc.
14) Journal Voucher (JV):- JVs are prepared for all adjustments which may not involve direct
financial dealings. For example, accounting of raw materials consumed in a particular
month, providing of depreciation or making provision for payment of royalty
i. As most of the adjustments are made at the end of the half year and at the end of the
year, therefore, all the JVs for the half yearly period or yearly period (month of
September or March in the case of units following April to March as accounting year)
must be verified.
ii. The narration given in the JVs should be studied in order to find out the exact nature
of transaction being entered in the books of accounts.
iii. Study of JVs may reveal accounting system followed by a unit. For example, a
company following the system of cost centres may account for consumption of raw
material for each centre on a monthly basis. In such cases, the raw material
consumption by non-production department like construction department or
maintenance department may be found out from the study of JVs which is passed at
the end of each month. The said JVs may also be useful in quantifying the amount of
wrong availment of ITC for entire year as only one JV is required to be examined for
each month.
iv. Adjustment entries passed for transferring the balance of one account to another
related account may also be found out from the study of JVs. For example, Recovery
of Packing and Forwarding Charges Account may be transferred to Packing and
Forwarding Expenses account and for this purpose a JV is passed.
v. Sometimes additional consideration may be collected from customer by issuing a
simple letter to the customer (without issuing any debit note or sales invoice). In such
cases these transactions are accounted for through JVs.
vi. Similarly, for quantities short received or rejected quantity also the supplier may be
compensated by way of intimation and the transaction is recorded through a JV.
15) Internal Audit Report: - This is the report submitted by internal auditors appointed by the
company which looks into day-to-day activities and the systems followed by the unit. In the
bigger company, it is mandatory also
i. Call for sample audit reports and examine with respect to observations on loss of any
input, excess availment of ITC, collection of additional consideration
ii. Verify whether any system changes have been advised and followed by the
assessee. In that case for the past period any implication on Excise payment due to
a week internal control needs to be examined.
iii. Internal Auditor also reports about stock verification and in case of shortages the ITC
availment needs to be examined.
Source: Handbook for Departmental Officers Audit/Scrutiny in GST Era by Radhe Krishna IRS
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