Guidance Note On Tax Audit Under Section 44 AB Of The Income - Tax Act

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Guidance Note On Tax Audit Under Section 44 AB Of The Income - Tax Act

1. Terms, abbreviations used in this Guidance Note.

In this Guidance Note the following terms and abbreviations occur often
in the text. A brief explanation of such terms and abbreviations is given
below. Further, reference to a section without reference to the relevant
Act means that the section has reference to the Income-tax Act, 1961.

(a) Act
The Income-tax Act, 1961.

(b) AS
Accounting Standards issued, prescribed and made mandatory by the
Institute of Chartered Accountants of India.

(c) AS(IT)
Accounting Standards notified by the Central Government under section
145(2).

(d) Assessee
As defined in section 2(7).

(e) Audit report
Any report submitted in Form No. 3CA/3CB along with the statement of
particulars in Form No. 3CD.

(f) Board
The Central Board of Direct Taxes constituted under the Central Boards
of Revenue Act, 1963.

(g) Circular
A circular or instructions issued by the Board under section 119(1).

(h) Form or Forms
Collectively refer to Forms 3CA, 3CB and 3CD.

(i) ICAI
The Institute of Chartered Accountants of India.

(j) Person
As defined in section 2(31).

(k) Previous year
As defined in section 3.

(l) Rules
The Income-tax Rules, 1962.

(m) Specified date
"Specified date", in relation to the accounts of the previous year
relevant to an assessment year means, in the case of a company, the
30th day of November of the relevant assessment year and in any other
case, the 31st day of October of the relevant assessment year.

(n) Tax audit
The audit carried out under the provisions of section 44AB.

(o) Tax auditor
Auditor appointed by an assessee to carry out tax audit.

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2. Introduction

2.1 The Act provides for audit of accounts and/or report/certificate of a
chartered accountant in the following cases :-

(i) Public charitable or religious trusts or institutions under section
12A(b).
(Form No.10B)

(ii) Assessees carrying on the business of growing and
manufacturing tea claiming deduction under section 33AB.
(Form No.3AC)

(iii) Assessees carrying on business consisting of the prospecting
for, or extraction or production of, petroleum or natural gas or
both in India and in relation to which the Central Government has
entered into an agreement for the purpose of deposit in Site
Restoration Account under section 33ABA.

(Form No.3AD)

(iv) Assessees other than companies or co-operative societies
claiming amortisation of certain preliminary expenses under
section 35D and deduction for expenditure on prospecting etc.
for certain minerals under section 35E.

(Form No.3B)

(v) Assessees incurring any expenditure on or after 1.4.1999 wholly
and exclusively in respect of a non-Y2K compliant computer
system under section 36 (1)(xi).

(Form No.3BA)

(vi) Assessees carrying on business or profession whose sales,
turnover or gross receipts exceed Rs.40 lakhs (Rs.10 lakhs in
the case of profession), and assessees who claim their income
to be lower than the profits or gains deemed to be the profits and
gains of their business under sections 44AD, 44AE or 44AF.

(Forms No.3CA/3CB/ and 3CD)

(vii) Assessees who have been ordered by the Assessing Officer with
the previous approval of the Chief Commissioner or
Commissioner under section 142(2A) to get their books of
account audited having regard to the nature and complexity of
the accounts of the assessee and the interests of the revenue.

(Form No. 6B)

(viii) Assessees other than companies or co-operative societies
claiming deduction under section 80HH in respect of profits from
newly established industrial undertakings or hotel business in
backward areas.

(Form No.10C)

(ix) Assessees other than companies or co-operative societies
claiming deduction under section 80HHA in respect of profits
from newly established small scale industrial undertakings in
rural areas.

(Form No.10C)

(x) Assessees other than companies or co-operative societies
claiming deduction under section 80HHB in respect of profits
from projects outside India.

(Form No.10CCA)

(xi) Assessees claiming deduction under section 80HHBA in respect
of profits and gains from housing projects.

(Form No.10CCAA)

(xii) Assessees being supporting manufacturers claiming deduction
under section 80HHC in respect of profits on sale of goods and
the merchandise to the recognised Export House/Trading House.

(Form No.10CCAB)

(xiii) Assessees claiming deduction under section 80HHC in respect
of export profits.

(Form No.10CCAC)

(xiv) Assessees claiming deduction under section 80HHD in respect
of profits from services provided to foreign tourists.

(Form No.10CCAD)

(xv) Assessees claiming deduction under section 80HHE in respect
of profits from the export of computer software.

(Form No.10CCAF)

(xvi) Assessees being supporting software developers claiming
deduction under section 80HHE in respect of profits on sale of
computer software to exporting company.

(Form No.10CCAG)

(xvii) Assessees being Indian companies, claiming deduction under
section 80HHF in respect of profits derived from the business of
export or transfer out of India of film software etc.

(Form No.10CCAI)

(xviii) Assessees other than companies or co-operative societies
claiming deduction under section 80-I in respect of profits and
gains from newly established industrial undertakings, ships or
hotel business set up after 31st March, 1981.

(Form No. 10CCB)

(xix) Assessees other than companies or co-operative societies
claiming deduction under section 80-IA in respect of profits and
gains derived from industrial undertakings etc.

(Form No. 10CCB)

(xx) Assessees claiming deduction under sub-section (7A) of section
80-IA in respect of profits and gains of business of housing or
other activities which are an integral part of a highway project.

(Form No. 10CCC)

(xxi) Assessees, being Indian companies, claiming deduction under
section 80JJAA, in respect of employment of new workers.

(Form No. 10DA)

2.2 The Guidance Note relating to the audit under section 44AB was first
published in the year 1985 and revised in the years 1989 and 1998.
The Government has substituted revised Rule 6G and Forms 3CA, 3CB
and 3CD in the Official Gazette on June 4, 1999, vide Notification No.
10950/F.No. 153/74/98/TPL and omitted Forms No.3CC and 3CE.
Hence, any tax audit report signed after 4

th June, 1999 for any
assessment year should be issued in the revised Form Nos. 3CA or
3CB along with the statement of particulars in Form No. 3CD, as the
case may be. Since the requirements under the revised forms are quite
different and enlarged as compared to the earlier forms, it has now
become necessary to revise the Guidance Note. The revised Form No.
3CD is quite comprehensive and covers generally all the items included
in Form No.6B prescribed for reporting under section 142(2A) and
hence this Guidance Note would meet almost all the reporting
requirements of audit under section 142(2A) also. However, if under
section 142(2A), the Assessing Officer requires special information, the
same has to be given separately along with Form No. 6B.
2.3 The Institute has published separate Guidance Notes for audit of Public
Trusts under section 12A(b) and for audits required for claiming
deduction under sections 80HHB/80HHC.
2.4 The tax audit was introduced by section 11 of the Finance Act, 1984,
which inserted a new section 44AB with effect from 1st April, 1985
[Assessment Year 1985-86]. This section makes it obligatory for a
person carrying on business to get his accounts audited by a chartered

accountant, and to furnish by the `specified date', the report in the
prescribed form of such audit, if the total sales, turnover or gross
receipts in business in the relevant previous year exceed or exceeds
Rs.40 lakhs. For a professional, the provisions of tax audit become
applicable, if his gross receipts in profession exceed Rs.10 lakhs. As
observed by the Finance Minister, while presenting the Union Budget
for 1984-85, and as stated in the Memorandum explaining the
provisions of the Finance Bill, 1984, the compulsory audit is intended to
ensure proper maintenance of books of account and other records, in
order to reflect the true income of the tax payer and to facilitate the
administration of tax laws by a proper presentation of the accounts
before the tax authorities. This would also save the time of the
Assessing Officers considerably in carrying out the verification. The
scope of section 44AB was enlarged by the Finance Act, 1997 to
provide, w.e.f. Assessment Year 1998-99, that audit under the section
would be required in case of a person carrying on the business of the
nature referred to in section 44AD or 44AE or 44AF, if such person
claims that his income is lower than the amount of income deemed
under these sections as presumptive income.
2.5 The

vires of section 44AB has been upheld by Hon'ble Supreme Court
in T.D. Venkata Rao v. Union of India [1999] 237 ITR 315 (SC). The
Apex Court has made the following significant observations:

"Chartered Accountants, by reason of their training
have special aptitude in the matter of audits. It is
reasonable that they, who form a class by themselves,
should be required to audit the accounts of
businesses whose income (sic: turnover) exceeds
Rs.40 lakhs and professionals whose income (sic:
gross receipts) exceeds Rs.10 lakhs in any given year.
There is no material on record and indeed in our view,
there cannot be that an income-tax practitioner has the
same expertise as chartered accountants in the matter
of accounts. For the same reasons the challenge
under article 19 must fail, and it must be pointed out
that these inome-tax practitioners are still entitled to
be authorised representatives of assessees.”

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3. Provisions of section 44AB

3.1 Section 44AB reads as under :-

"Audit of accounts of certain persons carrying on business or profession.

44AB. Every person, --
(a) carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds forty lakh rupees in any previous year; or
(b) carrying on profession shall, if his gross receipts in profession exceed ten lakh rupees in any previous year; or
(c) carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD or section 44AE or section 44AF, as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any previous year, get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed: Provided that this section shall not apply to the person, who derives income of the nature referred to in section 44B or section 44BB or
section 44BBA or section 44BBB, on and from the 1st day of April, 1985 or, as the case may be, the date on which the relevant section came into force, whichever is later: Provided further that in a case where such person is required by or under any other law to get his accounts audited, it shall be sufficient compliance with the provisions of this section if such person gets the accounts of such business or profession audited under such law before the specified date and furnishes by that date the report of the audit as required under such other law and a further report in the form
prescribed under this section.

Explanation - For the purposes of this section, -

(i) "accountant" shall have the same meaning as in the Explanation below sub-section (2) of section 288;

(ii) "specified date", in relation to the accounts of the previous year relevant to an assessment year means, -

(a) where the assessee is a company, the 30th day of November of the assessment year;
(b) in any other case, the 31st day of October of the assessment year."

3.2. The above section stipulates that every person carrying on business or profession is required to get his accounts audited by a chartered accountant before the "specified date" and furnish by that date the report of such audit, if the total sales, turnover or gross receipts exceed Rs.40 lakhs in the case of business and gross receipts exceed Rs.10 lakhs in the case of profession - vide clauses (a) and (b) of section 44AB.

3.3. Clause (c) of section 44AB, inserted by the Finance Act 1997 w.e.f. assessment year 1998-99, provides that in the case of an assessee carrying on a business of the nature specified in sections 44AD, 44AE or 44AF, tax audit will be required, if he claims his income to be lower than the presumptive income deemed under the said sections. Therefore, an assessee will be required to get his accounts auditedeven if his turnover does not exceed Rs.40 lakhs.

3.4. Under the provisions of sections 44AD and 44AF, an assessee can opt to be assessed on presumptive basis, so long as the gross receipts/total turnover from any of the business(es) do not exceed Rs.40 lakhs. Once the total turnover/gross receipts from any such business(es) exceed
Rs.40 lakhs, a tax audit will be required under clause (a) of section 44AB. The provisions of sections 44AA and 44AB shall not apply insofar as they relate to the business of civil construction, etc. as referred to in section 44AD(1), the business of plying, hiring or leasing goods carriages as referred to in section 44AE(1) and retail business as referred to in section 44AF(1). In computing the monetary limits under sections 44AA and 44AB, the turnover/gross receipts, or, as the case
may be, the income from the said business shall be excluded.

3.5. If a person is carrying on business(es), coming within the scope of sections 44AD, 44AE or 44AF, but he exercises his option given under these sections to get his accounts audited under section 44AB, tax audit requirements would apply, in respect of such business(es) even if the turnover of such business(es) does not exceed Rs.40 lakhs. In the case of a person carrying on businesses covered by section 44AD, 44AE or 44AF and opting for presumptive taxation, tax audit
requirement would not apply in respect of such businesses. If such person is carrying on other business(es) not covered by presumptive
taxation, tax audit requirements would apply in respect thereof, if the turnover of such business(es), other than the business(es) covered by presumptive taxation thereof, exceed Rs.40 lakhs.

3.6. The first proviso to section 44AB stipulates that the provisions of that section will not be applicable to a person who derives income of the nature referred to in sections 44B, 44BB, 44BBA or 44BBB. Where the assessee is carrying on any one or more of the businesses specified in
section 44B or section 44BB or section 44BBA or section 44BBB referred to in the first proviso to section 44AB, the sales/turnover/gross receipts from such businesses shall not be included in the total sales/turnover/gross receipts for determining the applicability of section 44AB.

3.7. The report of such audit, duly signed and verified by the chartered accountant is required to be given in such form and setting forth such particulars as prescribed by the Board. Rule 6G provides that such audit report and particulars should be given in Forms No. 3CA/3CB as may be applicable and the statement of particulars should be given in Form No.3CD.

3.8. A question may arise in the case of an assessee who is eligible to claim deductions under sections 80HH, 80HHA, 80HHC, 80HHD, 80HHE, 80HHF, 80-I or 80-IA etc., as to whether it will be necessary for him to get separate audit reports/certificates under these sections in addition to an audit report under section 44AB. The requirement of section 44AB is a general requirement covering the overall position of the accounts of the assessee. This applies to the consolidated accounts of the assessee for the relevant previous year covering the results of all the units owned by the assessee whether situated at one place or at different places. Therefore, when the turnover of all the units put together exceed the prescribed limits, the assessee will have to get the audit report under section 44AB in the prescribed form and separate audit reports in the forms prescribed for different purposes like sections 80HH, 80HHA etc. will have to be further obtained by the assessee to meet the specific requirements of the relevant sections.

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4. `Profession' and `business' explained

4.1. The term "business" is defined in section 2(13) of the Act, as under :-
"Business" includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. The word `business' is one of wide import and it means activity carried on continuously and systematically by a person by the application of his labour or skill with a view to earning an income. The expression "business" does not necessarily mean trade or manufacture only -

Barendra Prasad Roy v ITO [1981] 129 ITR 295 (SC).

4.2 Section 2(36) of the Act defines profession to include vocation. Profession is a word of wide import and includes "vocation" which is only a way of living. - CIT v. Ram Kripal Tripathi [1980] 125 ITR 408 (All).

4.3 Whether a particular activity can be classified as `business' or `profession' will depend on the facts and circumstances of each case. The expression "profession" involves the idea of an occupation requiring purely intellectual skill or manual skill controlled by the intellectual skill of the operator, as distinguished from an operation which is substantially the production or sale or arrangement for the production or sale, of commodities. - CIT Vs. Manmohan Das (Deceased) [1966] 59 ITR 699 (SC). The following have been listed out as professions in section 44AA and
notified thereunder (Notifications No. SO-17(E) dated 12.1.77 and No. SO 2675 dated 25.9.1992):

(i) Accountancy
(ii) Architectural
(iii) Authorised Representative
(iv) Company Secretary
(v) Engineering
(vi) Film Artists/Actors, Cameraman, Director, Singer, Story-writer, etc.
(vii) Interior Decoration
(viii) Legal
(ix) Medical
(x) Technical Consultancy

4.4. The following activities have been held to be business :-

(i) Advertising agent
(ii) Clearing, forwarding and shipping agents - CIT v. Jeevanlal Lallubhai & Co. [1994] 206 ITR 548 (Bom).
(iii) Couriers
(iv) Insurance agent
(v) Nursing home
(vi) Stock and share broking and dealing in shares and securities -

CIT v. Lallubhai Nagardas & Sons [1993] 204 ITR 93 (Bom)

.

(vii) Travel agent.

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5. Sales, turnover, gross receipts

5.1. It will be noted that the provision relating to tax audit applies to every
person carrying on business, if his total sales, turnover or gross receipts
in business exceed Rs.40 lakhs and to a person carrying on a
profession, if his gross receipts from profession exceed Rs.10 lakhs in
any previous year. However, the term "sales", "turnover" or "gross
receipts" are not defined in the Act, and therefore the meaning of the
aforesaid terms has to be considered for the applicability of the section.

5.2 In the “Guidance Note on Terms Used in Financial Statements”
published by the Institute, the expression “Sales Turnover” (Item 15.01)
has been defined as under :-

“The aggregate amount for which sales are effected or
services rendered by an enterprise. The term `gross
turnover’ and `net turnover’ (or `gross sales’ and `net

sales’) are sometimes used to distinguish the sales
aggregate before and after deduction of returns and trade
discounts”.

5.3 The Guide to Company Audit issued by the Institute, while discussing
“sales”, states as follows : (Page 53 of 4th Edition, 1980)

“Total turnover, that is, the aggregate amount for which
sales are effected by the company, giving the amount of
sales in respect of each class of goods dealt with by the
company and indicating the quantities of such sales for
each class separately.
Note(i) The term `turnover' would mean the total sales
after deducting therefrom goods returned, price
adjustments, trade discount and cancellation of bills for the
period of audit, if any. Adjustments which do not relate to
turnover should not be made e.g. writing off bad debts,
royalty etc. Where excise duty is included in turnover, the
corresponding amount should be distinctly shown as a
debit item in the profit and loss account.”

5.4 The “Statement on the Amendments to Schedule VI to the Companies
Act, 1956” issued by the Institute, (Page 14, 1976 edition) while
discussing the disclosure requirements relating to `turnover’ states as
follows:-

“As regards the value of turnover, a question which may
arise is with reference to various extra and ancillary
charges. The invoices may involve various extra and
ancillary charges such as those relating to packing, freight,
forwarding, interest, commission, etc. It is suggested that
ordinarily the value of turnover should be disclosed
exclusive of such ancillary and extra charges, except in
those cases where because of the accounting system
followed by the company, separate demarcation of such
charges is not possible from the accounts or where the
company’s billing procedure involves a composite charge
inclusive of various services rather than a separate charge
for each service.

In the case of invoices containing composite charges, it
would not ordinarily be proper to attempt a demarcation of
ancillary charges on a proportionate or estimated basis.
For example, if a company makes a composite charge to
its customer, inclusive of freight and despatch, the charge
so made should accordingly be treated as part of the
turnover for purpose of this section. It would not be proper
to reduce the value of the turnover with reference to the
approximate value of the service relating to freight and
despatch. On the other hand, if the company makes a
separate charge for freight and despatch and for other
similar services, it would be quite proper to ignore such
charges when computing the value of the turnover to be
disclosed in the Profit and Loss Account. In other words,
the disclosure may well be determined by reference to the
company’s invoicing and accounting policy and may
thereby vary from company to company. For reasons of
consistency as far as possible, a company should adhere
to the same basic policy from year to year and if there is
any change in the policy the effect of that change may
need to be disclosed if it is material, so that a comparison
of the turnover figures from year to year does not become
misleading.”

5.5. The Statement on the Manufacturing and Other Companies (Auditors'
Report) Order, 1988 issued by the Institute in May 1989, while
discussing the term ‘turnover’ in paragraph 41(c) states as follows:

“The term ‘turnover’ for the purposes of this clause may be
interpreted to mean the aggregate amount for which sales
are effected or services rendered by an enterprise. If sales
tax and excise duty are included in the sale price, no
adjustment in respect thereof should be made for
considering the quantum of turnover. Trade discount can
be deducted from sales but not the commission allowed to
third parties. If however, the Excise duty and/or sales tax
recovered are credited separately to Excise Duty or Sales
Tax Account (being separate accounts) and payments to
the authority are debited in the same account, they would

not be included in the turnover. However, sales of scrap
shown separately under the heading ‘miscellaneous
income’ will have to be included in turnover”.

5.6. Considering that the words "Sales", "Turnover" and "Gross receipts" are
commercial terms, they should be construed in accordance with the
method of accounting regularly employed by the assessee. Section
145(1) provides that income chargeable under the head "Profits and
gains of business or profession" or "Income from other sources" should
be computed in accordance with either cash or mercantile system of
accounting regularly employed by the assessee. The method of
accounting followed by the assessee is also relevant for the
determination of sales, turnover or gross receipts in the light of the
above discussion.

5.7. Applying the above generally accepted accounting principles, a few
typical cases may be considered:

(i) Discount allowed in the sales invoice will reduce the sale price
and, therefore, the same can be deducted from the turnover.

(ii) Cash discount otherwise than that allowed in a cash memo/sales
invoice is in the nature of a financing charge and is not related to
turnover. The same should not be deducted from the figure of
turnover.

(iii) Turnover discount is normally allowed to a customer if the sales
made to him exceed a particular quantity. This being dependent
on the turnover, as per trade practice, it is in the nature of trade
discount and should be deducted from the figure of turnover
even if the same is allowed at periodical intervals by separate
credit notes.

(iv) Special rebate allowed to a customer can be deducted from the
sales if it is in the nature of trade discount. If it is in the nature of
commission on sales, the same cannot be deducted from the
figure of turnover.

(v) Price of goods returned should be deducted from the figure of
turnover even if the returns are from the sales made in the
earlier year/s.

(vi) Sale proceeds of fixed assets would not form part of turnover
since these are not held for resale.

(vii) Sale proceeds of property held as investment property will not
form part of turnover.

(viii) Sale proceeds of any shares, securities, debentures, etc., held
as investment will not form part of turnover. However if the
shares, securities, debentures etc., are held as stock-in-trade,
the sale proceeds thereof will form part of turnover.

5.8. A question may also arise as to whether the sales by a commission
agent or by a person on consignment basis forms part of the turnover of
the commission agent and/or consignee as the case may be. In such
cases, it will be necessary to find out, whether the property in the goods
or all significant risks, reward of ownership of goods belongs to the
commission agent or the consignee immediately before the transfer by
him to third person. If the property in the goods or all significant risks
and rewards of ownership of goods continue to belong to the principal,
the relevant sale price shall not form part of the sales/turnover of the
commission agent and/or the consignee as the case may be. If,
however, the property in the goods, significant risks and reward of
ownership belongs to the commission agent and/or the consignee, as
the case may be, the sale price received/receivable by him shall form
part of his sales/turnover.
In this context, it would be useful to refer to the CBDT Circular No.452
dated 17th March, 1986, where the Board has clarified the question of
applicability of section 44AB in the cases of Commission Agents,
Arhatias, etc. The Circular is published in Appendix I.

5.9. Share brokers, on purchasing securities on behalf of their customers, do
not get them transferred in their names but deliver them to the
customers who get them transferred in their names. The same is true in
case of sales also. The share broker holds the delivery merely on behalf
of his customer. The property in goods does not get transferred to the
share brokers. Only brokerage which is being accounted for in the
books of account of share brokers should be taken into account for
considering the limits for the purpose of section 44AB. However, in
case of transactions entered into by share broker on his personal
account, the sale value should also be taken into account for

considering the limit for the purpose of section 44AB. The case of a
sub-broker is not different from that of a share broker.

5.10. The term "gross receipts" is also not defined in the Act. It will include all
receipts whether in cash or in kind arising from carrying on of the
business which will normally be assessable as business income under
the Act. Broadly speaking, the following items of income and/or receipts
would be covered by the term "gross receipts in business":

i) Profits on sale of a licence granted under the Imports (Control)
Order, 1955 made under the Imports and Exports (Control) Act,
1947;

ii) Cash assistance (by whatever name called) received or
receivable by any person against exports under any scheme of
the Government of India;

iii) Any duty of customs or excise re-paid or repayable as drawback
to any person against exports under the Customs and Central
Excise Duties Drawback Rules, 1995;

iv) The aggregate of gross income by way of interest received by
the money lender;

v) Commission, brokerage, service and other incidental charges
received in the business of chit funds;

vi) Reimbursement of expenses incurred (e.g. packing, forwarding,
freight, insurance, travelling etc.) and if the same is credited to a
separate account in the books, only the net surplus on this account
should be added to the turnover for the purposes of Section 44AB;

vii) The net exchange rate difference on export sales during the year
on the basis of the guiding principle explained in (vi) above will
have to be added.

viii) Hire charges of cold storage;

ix) Liquidated damages;

x) Insurance claims - except for fixed assets;

xi) Sale proceeds of scrap, wastage etc. unless treated as part of
sale or turnover, whether or not credited to miscellaneous
income account;

xii) Gross receipts including lease rent in the business of operating
lease;

xiii) Lease rent or interest on financing in the business of finance
lease ; and

xiv) Hire charges and instalments received in the course of hire
purchase.

5.11. The following items would not form part of "gross receipts in business"
for purposes of section 44AB.

i) Sale proceeds of fixed assets;
ii) Sale proceeds of assets held as investments;
iii) Rental income unless the same is assessable as business
income;
iv) Dividends on shares except in the case of an assessee dealing
in shares;
v) Income by way of interest unless assessable as business
income;
vi) Reimbursement of customs duty and other charges collected by
a clearing agent;
vii) In the case of a recruiting agent, the advertisement charges
received by him by way of reimbursement of expenses incurred
by him;
viii) In the case of a travelling agent, the amount received from the
clients for payment to the airlines, railways etc. where such
amounts are received by way of reimbursement of expenses
incurred on behalf of the client. If, however, the travel agent is
conducting a package tour and charges a consolidated sum for
transportation, boarding and lodging and other facilities, then the
amount received from the members of group tour should form
part of gross receipts, and
ix) In the case of an advertising agent, the amount of advertising
charges recovered by him from his clients provided these are by
way of reimbursement. But if the advertising agent books the
advertisement space in bulk and recovers the charges from

different clients, the amount received by him from the clients will
not be the same as the charges paid by him and in such a case
the amount recovered by him will form part of his gross receipts.

5.12. Thus the principle to be applied is that if the assessee is merely
reimbursed for certain expenses incurred, the same will not form part of
his gross receipts. But in the case of charges recovered, which are not
by way of reimbursement of the actual expenses incurred, they will form
part of his gross receipts.

5.13. In the case of a professional, the expression "gross receipts" in
profession would include all receipts arising from carrying on of the
profession. A question may, however, arise as to whether the out of
pocket expenses received by him should form part of his gross receipts
for purposes of this section. Normally, in the case of solicitors,
advocates or chartered accountants, such out of pocket expenses
received in advance are credited in a separate client's account and
utilised for making payments for stamp duties, registration fees,
counsel's fees, travelling expenses etc. on behalf of the clients. These
amounts, if collected separately either in advance or otherwise, should
not form part of the "gross receipts". If, however, such out of pocket
expenses are not specifically collected but are included/collected by
way of a consolidated fee, the whole of the amount so collected shall
form part of gross receipts and no adjustment should be made in
respect of actual expenses paid by the professional person for and/or
on behalf of his clients out of the gross fees so collected. However, the
amount received by way of advance for which services are yet to be
rendered will not form part of the receipts, as such advances are the
liabilities of the assessee and cannot be treated as his receipts till the
services are rendered.

5.14. A question may arise in the case of an assessee carrying on
business and at the same time engaged in a profession as to what
are the limits applicable to him under section 44AB for getting the
accounts audited. In such a case if his professional receipts are,
say, rupees twelve lakhs but his total sales, turnover or gross
receipts in business are, say, rupees twenty two lakhs, it will be
necessary for him to get his accounts of the profession and also the
accounts of the business audited because the gross receipts from
the profession exceed the limit of rupees ten lakhs. If however, the

professional receipts are, say, rupees seven lakhs and total sales
turnover or gross receipts from business are, say, rupees thirty four
lakhs it will not be necessary for him to get his accounts audited
under the above section, because his gross receipts from the
profession as well as total sales, turnover or gross receipts from the
business are below the prescribed limits.

5.15. It may, however, be noted that in cases where the assessee carries on
more than one business activity, the results of all business activities
should be clubbed together. In other words, the aggregate sales, turnover
and/or gross receipts of all businesses carried on by an assessee would
be taken into consideration in determining whether the limit of Rs.40 lakhs
as laid down in this section has been exceeded or not. However, where
the business is covered by section 44B or 44BB or 44BBA or 44BBB,
turnover of such business shall be excluded. Similarly when the business
is covered by sections 44AD, 44AE and 44AF and the assessee opts to
be assessed under the respective sections on presumptive basis, the
turnover thereof shall be excluded. So far as a partnership firm is
concerned, each firm is an independent assessee for purposes of
Income-tax Act. Therefore, the figures of sales of each firm will have to
be considered separately for purposes of determining whether or not the
accounts of such firm are required to be audited for purposes of section
44AB.

5.16. It must also be understood that the issue whether the turnover exceeds
Rs.40 lakhs in the case of business or the gross receipts exceed Rs.10
lakhs in the case of profession is to be determined in each year
independent of the results obtained in the preceding year or years.
Further, this section applies only if the turnover exceeds the prescribed
limit according to the accounts maintained by the assessee. If the
Assessing Officer wants the assessee to get his accounts audited in
cases where the figures of turnover as appearing in the books of
account of the assessee do not exceed the prescribed limits, he has no
option but to pass an order under section 142(2A) directing the
assessee to get his accounts audited from a particular chartered
accountant as may be nominated by the Commissioner of Income-tax or
the Chief Commissioner of Income-tax.

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6. Liability to tax audit - special cases

6.1. A question may arise in the case of an assessee whose income is not chargeable to income-tax by reason of a specific exemption contained in the law or otherwise, as to whether he is required to get his accounts audited and to furnish such report under section 44AB. Such cases
may cover those assessees who are wholly outside the purview of income-tax law as well as those whose income is otherwise exempt under the Act. It is felt that neither section 44AB nor any other
provisions of the Act stipulate exemption from the compulsory tax audit to any person whose income is exempt from tax. This section makes it mandatory for every person carrying on any business or profession to get his accounts audited where conditions laid down in the section are
satisfied and to furnish the report of such audit in the prescribed form. A charitable trust carrying on business may enjoy exemption under sections 10(21), 10(23), 10(23B) or section 10(23BB) or section 10(23C) and a research association carrying on business may enjoy exemptions under section 10(21) and section 11. A co-operative society carrying on business may enjoy exemption under section 80P. Such institutions/ associations of persons will have to get their accounts
audited and to furnish such audit report for purposes of section 44AB if their turnover in business exceeds Rs.40 lakhs. But an agriculturist, who does not have any income under the head "Profits and gains of business or profession" chargeable to tax under the Act and who is not required to file any return under the said Act, need not get his accounts audited for purposes of section 44AB even though his total sales of agricultural products may exceed Rs.40 lakhs. It may be appreciated
that the object of audit under section 44AB is only to assist the Assessing Officer in computing the total income of an assessee in accordance with different provisions of the Act. Therefore, even if the income of a person is below the taxable limit laid down in the relevant Finance Act of a particular year, he will have to get his accounts audited and to furnish such report under section 44AB, if his turnover in business exceed Rs.40 lakhs.

6.2. The case of non-residents may be considered separately. Section 44AB does not make any distinction between a resident or non-resident. Therefore, a non-resident assessee is also required to get his accounts audited and to furnish such report under section 44AB if his turnover exceeds the prescribed limits. This audit, however, would be confined only to the Indian operations carried out by the non-resident assessee since he is not chargeable to income-tax in India in respect of income accruing or arising or received outside India.

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7. Specified date and tax audit

A question may arise whether a tax auditor appointed under section 44AB can be held responsible if he does not complete the audit and give his audit report before the specified date. Answer to this question will depend on the facts and circumstances of the case. Normally, it is the professional duty of the chartered accountant to ensure that the audit accepted by him is completed before the due date. If there is any unreasonable delay on his part, he is answerable to the Institute if the complaint is made by the client. However, if the delay in the completion of audit is attributable to his client, the tax auditor cannot be held responsible. In view of the fact that section 44AB does not give any discretion to the tax authorities to extend the time limit for completion of audit, the audit has to be completed within the time limit provided in this section. It is, therefore, necessary that no chartered accountant should accept audit assignments which he cannot complete within the above time frame. In this regard, reference may also be made to paragraph 12 of this Guidance Note.

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8. Penalty

8.1. In order to ensure proper compliance with section 44AB, section 271-B has been enacted which reads as under:-

"Failure to get accounts audited

271B. If any person fails to get his accounts audited in respect of any previous year or years relevant to an assessment year or furnish a report of such audit as required under section 44AB, the Assessing Officer may direct that such person shall pay, by way of penalty, a sum equal to one-half per cent of the total sales, turnover or gross receipts, as the case may be, in business, or of the gross receipts in profession, in such previous year or years or a sum of one hundred thousand rupees, whichever is less."

8.2. As such, the failure of a person, to get his accounts audited in respect of any previous year or furnish a copy of such report as required under section 44AB may attract a penalty equal to 0.5% of the total sales, turnover or gross receipts, or Rs.1 lakh whichever is less. However, in view of the specific provisions contained in section 273B, no penalty is imposable under section 271B on the assessee for the above failure if he proves that there was reasonable cause for the said failure. The onus of proving reasonable cause is on the assessee.

8.3. Some of the instances where Tribunals/Courts have accepted as "reasonable cause" are as follows :-
(a) Resignation of the tax auditor and consequent delay;
(b) Bona fide interpretation of the term `turnover' based on expert advice;
(c) Death or physical inability of the partner in charge of the accounts;
(d) Labour problems such as strike, lock out for a long period, etc.;
(e) Loss of accounts because of fire, theft, etc. beyond the control of the assessee;
(f) Non-availability of accounts on account of seizure;
(g) Natural calamities, commotion, etc.

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9. Tax auditor

9.1. The term "accountant" has been defined in sub-clause (i) of Explanation
to section 44AB as under:-

"Explanation, - For the purposes of this section, -

(i) "accountant" shall have the same meaning as in the Explanation
below sub-section (2) of section 288".
The above-mentioned Explanation reads as under:
`Accountant' means a chartered accountant within the meaning of
Chartered Accountants Act, 1949 (38 of 1949) and includes, in relation
to any State, any person, who by virtue of the provisions of sub-section
(2) of section 226 of the Companies Act, 1956 (1 of 1956), is entitled to
be appointed to act as an tax auditor of companies registered in that
State."

The proviso to section 44AB also lays down that where the accounts of
an assessee are required to be audited by or under any other law, it
shall be sufficient compliance with the provisions of this section, if such
person gets the accounts of such business or profession audited under
such other law before the specified date and furnishes by that date the
report of the audit as required under section 44AB. It may be noted that
with the deletion of the words "by an accountant" in the proviso to
section 44AB by the Finance Act, 1985 with effect from 1st April, 1985,
in the case of any assessee like a co-operative society where the
accounts under the relevant law are allowed to be audited by a person
other than a chartered accountant, the tax audit may also be conducted
by the statutory auditor who may not be a chartered accountant.

9.2. Though the section refers to the accounts being audited by an
accountant which means a chartered accountant as defined above, the
audit can also be done by a firm of chartered accountants. This has
been a recognised practice under the Act. In such a case, it would be
necessary to state the name of the partner who has signed the audit
report on behalf of the firm. The member signing the report as a partner
of a firm or in his individual capacity should give his membership
number below his name.

9.3. Section 44AB does not stipulate that only the statutory auditor
appointed under the Companies Act or other similar statute should
perform the tax audit. The tax audit can, therefore, be conducted either
by the statutory auditor or by any other chartered accountant in
practice.

9.4. A question may arise in the case of a public sector company or any
other company where the statutory auditor has not been appointed by
the authorities concerned as to whether the tax auditor appointed under
section 44AB can complete his audit without waiting for statutory audit
report on the accounts audited by the statutory auditors. It may be
noted that Form No. 3CA requires the tax auditor to enclose a copy of
the audit report conducted by the statutory auditor or the auditor of the
financial statements as the case may be. Where a statutory auditor has
not been appointed by the authorities concerned or where the report of
the statutory auditor is not available for whatever reasons, it will be
possible for the tax auditor to give his report in Form No. 3CB and to
certify the relevant particulars in Form No.3CD. This is particularly
important in those cases where the assessee concerned has suffered
losses in the relevant accounting year. It may, however, be noted that
the tax auditor in such cases will have to conduct the financial audit as
well in order to enable him to certify whether or not the accounts
reported upon by him give a true and fair view of the state of affairs of
the assessee whose accounts are audited by him under section 44AB.

9.5 Tax audit under section 44AB being a recurring audit assignment, for
expressing professional opinion on the financial statements and the
particulars, the member accepting the assignment should
communicate with the member who had done tax audit in the earlier
year as provided in the Chartered Accountants Act. In the case of a
person whose accounts of the business or profession have been
audited under any other law (i.e. a company, a co-operative society, etc.
which is required to get the accounts audited under a Statute) it is not
necessary to communicate with the statutory auditor if he had not done
tax audit in the earlier year. Attention of the members is invited to the
detailed discussion in the publication of ICAI, "Code of Conduct" under
clause (8) of Part I of the First Schedule to the Chartered Accountants
Act, 1949 vide Appendix II.

9.6 The tax auditor should obtain from the assessee a letter of appointment
for conducting the audit as mentioned in section 44AB. It is advisable
that such an appointment letter should be signed by the person
competent to sign the return of income in terms of the provisions of
section 140. The tax auditor should get the statement of particulars, as
required in the annexure to the audit report, authenticated by the
assessee before he proceeds to verify the same.

9.7. The tax auditor is required to submit his report to the person appointing
him viz. the assessee.

9.8. The appointment of the auditor for tax audit in the case of a company
need not be made at the general meeting of the members. It can be
made by the Board of Directors or even by any officer, if so authorised
by the Board in this behalf. The appointment in the case of a firm or a
proprietary concern can be made by a partner or the proprietor or a
person authorised by the assessee. It is possible for the assessee to
appoint two or more chartered accountants as joint auditors for carrying
out the tax audit, in which case, the audit report will have to be signed
by all the chartered accountants. In case of disagreement, they can
give their reports separately. In this regard, attention is invited to
paragraph 15 of the Statement on the Responsibility of Joint Auditors
reproduced below:

“ No problem arises if the joint auditors are able to arrive at
an agreed report. But, where joint auditors are in
disagreement with regard to the report, each one of them
would be justified in expressing his own opinion through a
separate report. Even where more than two joint auditors
are appointed, there is no question of majority or minority
with regard to the joint audit report. Each auditor is
entitled to express his own separate opinion and, in fact, it
is his duty to do so.”

The responsibility of joint tax auditors will be the same as in the case of
other audits e.g. audit under the Companies Act. For details relating to
such responsibility, in the case of joint tax audit, reference may be
made to "Statement on the Responsibility of Joint Auditors" issued by
ICAI. The same is reproduced in Appendix III.

9.9. The position of a tax auditor for conducting audit under section 44AB
will be considered as an office of profit. Therefore, the provisions of
section 314 of the Companies Act, 1956 will be attracted when a
relative of a director is appointed as a tax auditor of the company, if the
remuneration thereof exceeds the limits prescribed in the aforesaid
section. The necessary formalities will be required to be complied with
as required under section 314.

9.10. The Act does not prohibit a relative or an employee of the assessee
being appointed as a tax auditor under section 44AB. It may, however,
be noted that as per a decision of the Council (reported in the Code of
Conduct under clause(4) of Part I of Second Schedule), a chartered
accountant who is in employment of a concern or in any other concern
under the same management cannot be appointed as tax auditor of that
concern. Therefore, an employee of an assessee or an employee of a
concern under the same management cannot audit the accounts of an
assessee under section 44AB. It may also be noted that under the
Second Schedule to the Chartered Accountants Act, if a member gives
an audit report under section 44AB in the case of a concern in which he
and/or his relatives have substantial interest, it will be necessary for him
to disclose his interest in the audit report. Relevant extracts from the
Code of Conduct published by ICAI relating to disclosure of substantial
interest by a chartered accountant are given in Appendix IV.

9.11. A chartered accountant who is responsible for writing or the maintenance
of the books of account of the assessee should not audit such accounts.
This principle will apply to the partner of such a member as well as to the
firm in which he is a partner. In view of this, a chartered accountant who is
responsible for writing or the maintenance of the books of account or his
partner or the firm in which he is a partner should not accept tax audit
assignment under section 44AB in the case of such an assessee.

9.12. The audit of accounts of a professional firm of chartered accountants,
under section 44AB cannot be conducted by any partner or employee of
such firm.

9.13. A chartered accountant/firm of chartered accountants, who is appointed
as tax consultant of the assessee, can conduct tax audit under section
44AB. But an internal auditor of the assessee cannot conduct tax audit
if he is an employee of the assessee. If the internal auditor is working
in a professional capacity (as an independent chartered accountant not
being an employee of the assessee), he can conduct the tax audit.

9.14. A question may arise whether an assessee can remove a tax auditor
appointed under section 44AB. The answer depends upon the facts and
circumstances of the case. There is no specific procedure for removal of a
tax auditor appointed under section 44AB. It is, however, possible for the
management to remove a tax auditor where there are any valid grounds for
such removal. This may arise where the tax auditor has delayed the
submission of audit report under section 44AB for an unreasonable period
and if it is found that there is no possibility of getting the audit report before
the specified date. In such cases, the assessee may be justified in
removing the tax auditor. However, the tax auditor cannot be removed on
the ground that he has given an adverse audit report or the assessee has
an apprehension that the tax auditor is likely to give an adverse audit report.
If there is any unjustified removal of tax auditors, the concerned committee
constituted by the Institute can intervene in such cases. No other chartered
accountant should accept the audit assignment if the removal of his
predecessor is not on valid grounds.

9.15. Before accepting a tax audit, the chartered accountant should take into
consideration the ceiling on tax audit assignments fixed under the
Notification dated 13th January, 1989, issued by the ICAI. A copy of
this Notification is appended as Appendix V.

9.16. In view of the said Notification, a member of the Institute in practice,
shall be deemed to be guilty of professional misconduct if he accepts in
a financial year more than 30 tax audit assignments or such other limit
as may be prescribed by ICAI from time to time under section 44AB,
whether in respect of a person whose accounts have been audited
under any other law or a person who carries on business or profession
but who is not required by or under any other law to get his accounts
audited. Further, as per a Council decision, audits of accounts of
persons carrying on business covered by sections 44AD, 44AE or
44AF, is not included in the aforesaid limit. In case the member is a
partner of a firm of chartered accountants in practice, the ceiling of 30
tax audit assignments shall be computed with reference to each of the
partner in the said firm. Where any partner of the firm of chartered
accountants in practice is also a partner of any other firm or firms of
chartered accountants in practice, the ceiling limit of 30 shall apply with
reference to all the firms together in relation to such partner. Similarly,
where any partner accepts one or more tax audit assignments in his
individual capacity, the total number of such assignments under section
44AB which may be accepted by him whether directly in his individual
capacity or as partner of the firm of chartered accountants in practice
shall not exceed 30 tax audit assignments. If two members or firms of
chartered accountants are appointed as joint tax auditors, then the
assignment will have to be included in the case of both the members or
firms separately. It has, however, been clarified that the audit of the
head office and branch offices concerned shall be regarded as one tax
audit assignment. Similarly, the audit of one or more branches of the
same concern by one chartered accountant in practice shall be
construed as only one tax audit assignment. In computing the specified
number of tax audit assignments each year's audit would be taken as a
separate assignment. Every chartered accountant in practice shall
maintain a record of the tax audit assignments accepted by him in each
financial year in the format prescribed by the Council. This format is
reproduced in Appendix VI.

9.17. No separate guidelines have been prescribed for tax audit fees under
section 44AB. The Institute has recommended fees for professional
services on the basis of time devoted by a chartered accountant and his
assistants. The fees for tax audit assignment can be charged by a
chartered accountant on the basis of the work involved in the
assignment. It will be appreciated that no uniform fees can be
recommended on the basis of turnover because an assessee having
turnover of Rs.1 crore in a trading activity may have less transactions
as compared to an assessee having the same turnover in a
manufacturing activity. Similarly the transactions in a wholesale
business will be less than the transactions in a retail business. The
scale of fees effective from 1.4.1995 recommended by the Institute for
professional services is given in Appendix VII (published in `The
Chartered Accountant', April, 1995 p.1402). The Council has also
clarified that the scale does not include fees chargeable in respect of
non-qualified assistants and that the chartered accountants are free to
negotiate the terms in respect of such assistants with the clients.
The chartered accountants should charge reasonable fees depending
upon the responsibility involved under the revised forms and taking into
consideration the work involved in tax audit assignment which has
increased considerably consequent to the revision of the forms. It is
necessary that members of the profession should also maintain
reasonable standards of professional fees.

9.18. Attention is also invited to Notification No.1-CA/(7)/29/95 dated 1st
March, 1995 of the Institute (published in `The Chartered Accountant',
April, 1995 p.1394) which prescribes minimum fees to be charged by
certain specified categories of firms. The Notification is reproduced as
Appendix - VIII. The notification does not apply to certification or audit
under Income-tax Act by the statutory auditor. The limits specified in
the notification will therefore apply only if tax audit is conducted by a
firm other than that of statutory auditors. Also, where tax audit and
statutory audit are done by the same firm, the total fee for both
assignments shall be reckoned for the purpose.

9.19

As mentioned in Paragraph 9.16 above, the audit of the head office and

branch offices of an assessee shall be regarded as one tax audit

assignment.

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10. Accounting Standards

10.1. Recognising the need to harmonise the diverse accounting policies and
practices in use in India and keeping in view the International
developments in the field of accounting, the Council of the Institute has
issued AS.

10.2. AS are formulated by the Accounting Standards Board and issued by
the Council of the Institute. Such Standards are issued for use in the
presentation of general purpose financial statements which are issued
to the public by such commercial, industrial or business enterprises as
may be specified by the Institute from time to time and subject to the
attest function of its members. The term `General Purpose Financial
Statements' includes balance sheet, statement of profit and loss and
other statements and explanatory notes which form part thereof, issued
for the use of shareholders/members, creditors, employees and public
at large.

10.3. The Institute has so far issued fifteen definitive standards as follows:
AS-1 Disclosure of Accounting Policies
AS-2 (Revised) Valuation of Inventories
AS-3 (Revised) Cash Flow Statements
AS-4 (Revised) Contingencies and Events Occurring After the Balance
Sheet Date.
AS-5 (Revised) Net Profit or Loss for the period, Prior Period items
and changes in Accounting policies
AS-6 (Revised) Depreciation Accounting
AS-7 Accounting for Construction Contracts
AS-8 Accounting for Research and Development
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 (Revised) Accounting for the Effects of Changes in Foreign
Exchange Rates
AS-12 Accounting for Government Grants
AS-13 Accounting for Investments
AS-14 Accounting for Amalgamations
AS-15 Accounting for Retirement Benefits in the Financial Statements
of Employer

Out of the 15 Standards issued so far, 14 have been made mandatory
except AS-3 Cash Flow Statements (Revised). It may be noted that AS-
2 (Revised) Valuation of Inventories has been made mandatory from
accounting year starting from 1.4.1999. The mandatory AS also apply in
respect of financial statements audited under section 44AB of the
Income-tax Act, 1961. Accordingly, members should examine
compliance with the mandatory accounting standards when conducting
such audit.

10.4. AS apply in respect of commercial, industrial or business activities of an
enterprise. In the case of charitable or religious organisations, AS will
not apply if all activities of such organisations are not of commercial,
industrial or business nature (e.g. an activity of collecting donations and
giving them to flood affected people). In other words, exclusion of an
entity from the applicability of the AS would be permissible only if no
part of the activity of such entity is commercial, industrial or business in
nature. Even if a very small portion of the activities of an entity is
considered to be commercial, industrial or business in nature, then it
cannot claim exemption from the application of AS. The AS would
apply to all its activities including those which are not commercial,
industrial or business in nature.

10.5 The Companies Act, 1956, as well as many other statutes require that
the financial statements of an enterprise should give a true and fair
view of its financial position and working results. This requirement is
implicit even in the absence of a specific statutory provision to this
effect. However, what constitutes `true and fair' view has not been
defined either in the Companies Act, 1956,or in any other statute. The
Accounting Standards (as well as other pronouncements of the
Institute on accounting matters) seek to describe the accounting
principles and the methods of applying these principles in preparation
and presentation of financial statements so that they give a true and
fair view.

In this connection, it may be noted that sub-section (3A) of section 211
of the Companies Act, 1956, newly inserted by the Companies
(Amendment) Act, 1999 w.e.f. 31.10.1998 provides that every profit and
loss account and balance sheet of a company shall comply with the
accounting standards. Sub-section (3B) thereof, also newly inserted,
provides that where the profit and loss account and the balance sheet of

the company do not comply with the accounting standards, such
companies shall disclose in its profit and loss account and balance
sheet, the following namely:-
(i) the deviation from the accounting standards;
(ii) the reasons for such deviation; and
(iii) the financial effect, if any, arising due to such deviation.
Sub-section (3C) provides that for the purposes of section 211, the
expression "accounting standards" means the standards of accounting
recommended by the Institute of Chartered Accountants of India as may
be prescribed by the Central Government in consultation with the
National Advisory Committee on Accounting Standards established
under sub-section (1) of section 210A. The proviso under sub-section
(3C) provides that the standards of accounting specified by the Institute
of Chartered Accountants of India shall be deemed to be the Accounting
Standards until the accounting standards are prescribed by the Central
Government under sub-section (3C).
Further, sub-clause (d) has been inserted in sub-section (3) of
section 227 to provide that the auditors' report shall also state
whether, in his opinion, the profit and loss account and balance
sheet comply with the accounting standards referred to in subsection
(3C) of section 211.

10.6. The `Preface to the Statements of Accounting Standards', issued by the
Institute,

inter alia, states:

"While discharging their attest function, it will be the duty
of the members of the Institute to ensure that the
Accounting Standards are implemented in the presentation
of financial statements covered by their audit reports. In
the event of any deviation from the Standards, it will be
also their duty to make adequate disclosures in their
reports so that the users of such statements may be aware
of such deviations."

10.7. While discharging their attest function, the members of the Institute may
keep the following in mind with regard to the mandatory AS.

AS 1 Disclosure of Accounting Policies-AS 1.

In the case of a company, members should qualify their audit reports in
case:

(a) accounting policies required to be disclosed under Schedule VI
or any other provisions of the Companies Act, 1956, have not
been disclosed, or
(b) accounts have not been prepared on accrual basis, or
(c) the fundamental accounting assumptions of going concern and
consistency have not been followed and this fact has not been
disclosed in the financial statements, or
(d) proper disclosures regarding changes in the accounting policies
have not been made.
(e) Accounting Standards referred to in section 211(3C) of the
Companies Act, 1956 have not been followed.
Where a company has been given a specific exemption regarding any
of the matters stated above, but the fact of such exemption has not
been adequately disclosed in the accounts, the member should mention
the fact of exemption in his audit report without necessarily making it a
subject matter of audit qualification.

10.8 In the case of an enterprise other than a company, members should
qualify their audit reports in case AS issued, prescribed and made
mandatory by the ICAI have not been followed.


10.9

Financial Statements prepared on a basis other than accrual.

With regard to the fundamental accounting assumption of accrual, the
Council has made a specific announcement that in respect of (a) Sole
proprietary concerns/individuals, (b) Partnership firms, (c) Societies
registered under the Societies Registration Act, (d) Trusts, (e) Hindu
undivided families and (f) Association of persons, the auditor should
examine whether the financial statements have been prepared on
accrual basis. In case where the statute governing the enterprise
requires the preparation and presentation of financial statements on
accrual basis but the financial statements have not been so prepared,
the auditor should qualify his report. On the other hand where there is
no statutory requirement for preparation and presentation of fianancial

statements on accrual basis, and the financial statements have been
prepared on a basis other than ‘accrual’, the auditor should describe in
his audit report, the basis of accounting followed, without necessarily
making it a subject matter of a qualification. In such a case the auditor
should also examine whether those provisions of the AS which are
applicable in the context of the basis of accounting followed by the
enterprise have been complied with or not and consider making suitable
qualifications in his audit report accordingly.

10.10.

Accounting Standards under Taxation Law:

The Finance Act, 1995 substituted a new section 145 w.e.f. assessment
year 1997-98. The section deals with method of accounting and is
reproduced below :-

"145.

(1) Income chargeable under the head "Profits and
gains of business or profession" or "Income from other
sources" shall, subject to the provisions of sub-section (2),
be computed in accordance with either cash or mercantile
system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official
Gazette from time to time accounting standards to be
followed by any class of assessees or in respect of any
class of income.
(3) Where the Assessing Officer is not satisfied about the
correctness or completeness of the accounts of the
assessee, or where the method of accounting provided in
sub-section (1) or accounting standards as notified under
sub-section (2), have not been regularly followed by the
assessee, the Assessing Officer may make an assessment
in the manner provided in section 144."

10.11

Standards notified by Government -AS(IT):

In exercise of the powers conferred by section 145(2), the Central
Government has by Notification No. S.O.69(E), dated 25th January,
1996 notified two AS(IT). This notification came into force with effect
from 1st day of April, 1996, and is accordingly applicable from
assessment year 1997-98 and subsequent assessment years.

These AS(IT) are given below:

Accounting Standards to be followed by all assessees following
mercantile system of accounting
A. Accounting Standard I relating to disclosure of accounting
policies

1. All significant accounting policies adopted in the preparation and
presentation of financial statements shall be disclosed.
2. The disclosure of the significant accounting policies shall form
part of the financial statements and the significant accounting
policies shall normally be disclosed in one place.
3. Any change in an accounting policy which has a material effect
in the previous year or in the years subsequent to the previous
years shall be disclosed. The impact of, and the adjustments
resulting from such change, if material, shall be shown in the
financial statements of the period in which such change is made
to reflect the effect of such change. Where the effect of such
change is not ascertainable, wholly or in part, the fact shall be
indicated. If a change is made in the accounting policies which
has no material effect on the financial statements for the
previous year but which is reasonably expected to have a
material effect in any year subsequent to the previous year, the
fact of such change shall be appropriately disclosed in the
previous year in which the change is adopted.
4. Accounting policies adopted by an assessee should be such so
as to represent a true and fair view of the state of affairs of the
business, profession or vocation in the financial statements
prepared and presented on the basis of such accounting
policies. For this purpose, the major considerations governing
the selection and application of accounting policies are the
following, namely:

(i) Prudence - Provisions should be made for all known
liabilities and losses even though the amount cannot be
determined with certainty and represents only a best
estimate in the light of available information;

(ii) Substance over form - The accounting treatment and
presentation in financial statements of transactions and
events should be governed by their substance and not
merely by the legal form;

(iii) Materiality - Financial statements should disclose all
material items, the knowledge of which might influence
the decisions of the user of the financial statements.

5. If the fundamental accounting assumptions relating to going
concern, Consistency and Accrual are followed in financial
statements, specific disclosure in respect of such assumptions is
not required. If a fundamental accounting assumption is not
followed, such fact shall be disclosed.

6. For the purposes of paragraphs (1) to (5), the expressions, -

(a) "Accounting policies" means the specific accounting
principles and the methods of applying those principles
adopted by the assessee in the preparation and
presentation of financial statements;

(b) "Accrual" refers to the assumption that revenues and
costs are accrued, that is, recognised as they are earned
or incurred (and not as money is received or paid) and
recorded in the financial statements of the periods to
which they relate;

(c) "Consistency" refers to the assumption that accounting
policies are consistent from one period to another;

(d) "Financial statements" means any statement to provide
information about the financial position, performance and
changes in the financial position of an assessee and
includes balance sheet, profit and loss account and other
statements and explanatory notes forming part thereof;

(e) "Going concern" refers to the assumption that the
assessee has neither the intention nor the necessity of
liquidation or of curtailing materially the scale of the
business, profession or vocation and intends to continue
his business, profession or vocation for the foreseeable
future.

B. Accounting Standard II relating to disclosure of prior period and
extraordinary items and changes in accounting policies:

7. Prior period items shall be separately disclosed in the profit and
loss account in the previous year together with their nature and
amount in a manner so that their impact on profit or loss in the
previous year can be perceived.

8. Extraordinary items of the enterprise during the previous year
shall be disclosed in the profit and loss account as part of
income. The nature and amount of each such item shall be
separately disclosed in a manner so that their relative
significance and effect on the operating results of the previous
year can be perceived.

9. A change in an accounting policy shall be made only if the
adoption of a different accounting policy is required by statute or
if it is considered that the change would result in a more
appropriate preparation or presentation of the financial
statements by an assessee.

10. Any change in an accounting policy which has a material effect shall
be disclosed. The impact of, and the adjustments resulting from
such change, if material, shall be shown in the financial statements
of the period in which such change is made to reflect the effect of
such change. Where the effect of such change is not ascertainable,
wholly or in part, the fact shall be indicated. If a change is made in
the accounting policies which has no material effect on the financial
statements for the previous year but which is reasonably expected
to have a material effect in years subsequent to the previous years,
the fact of such change shall be appropriately disclosed in the
previous year in which the change is adopted.

11. A change in an accounting estimate that has a material effect in
the previous year shall be disclosed and quantified. Any change
in an accounting estimate which is reasonably expected to have
a material effect in years subsequent to the previous year shall
also be disclosed.

12. If a question arises as to whether a change is a change in
accounting policy or a change in an accounting estimate, such a
question shall be referred to the Board for decision.

13. For the purposes of paragraphs (7) to (12), the expressions:

(a) "Accounting estimate" means an estimate made for the
purpose of preparation of financial statements which is
based on the circumstances existing at the time when the
financial statements are prepared;

(b) "Accounting policies" means the specific accounting
principles and the method of applying those principles
adopted by the assessee in the preparation and
presentation of financial statements;

(c) "Extraordinary items" means gains or losses which arise
from events or transactions which are distinct from the
ordinary activities of the business and which are both
material and expected not to recur frequently or regularly.
Extraordinary items include material adjustments
necessitated by circumstances which though related to
the years preceding the previous years are determined in
the previous year:

Provided that income or expenses arising from the ordinary
activities of the business or profession or vocation of an
assessee, though abnormal in amount or infrequent in
occurrence, shall not qualify as extraordinary items;

(d) "Financial statements" means any statement to provide
information about the financial position, performance and
changes in the financial position of an assessee and
includes balance sheet, profit and loss account and other
statements and explanatory notes forming part thereof;

(e) "Prior period items" means material charges or credits
which arise in the previous year as a result of errors or
omissions in the preparation of the financial statements of
one or more previous years:
Provided that the charge or credit arising on the outcome of a
contingency, which at the time of occurrence could not be estimated
accurately shall not constitute the correction of an error but a change in
estimate and such an item shall not be treated as a prior period item.

The above Accounting Standards are to be followed by all
assessees following mercantile system of accounting. Therefore,
it is clear that those assessees who are following cash system of
accounting need not follow the Accounting Standards notified
above.

10.12.

Implications of non-compliance with the AS and AS(IT)

As mentioned earlier, AS are applicable to tax audit also when the tax
auditor performs the attest function, i.e., report on whether the accounts
are true and fair. Therefore, in case of non-compliance with the AS, the
chartered accountant should make appropriate
qualifications/disclosures in the audit report. However, such
qualifications/disclosures may or may not have any impact on the
computation of total income for the purpose of the Act. Similarly,
section 145 provides that the AS(IT) notified under that section should
be followed by the assessees to whom they are made applicable. It
should be noted that the tax auditor auditing accounts under section
44AB is not computing the income but is - (a) reporting on accounts,
and (b) reporting on the relevant information furnished in Form No.
3CD. Now, the revised Form No. 3CD

vide clause 11(d) requires
reporting of the details of deviation, if any, in the method of accounting
employed in the previous year from accounting standards prescribed
under section 145 and the effect thereof on the profit or loss. Further, it
may be noted that there is no material difference between AS(IT)-1 and
AS(IT)-2 notified by the Government and the corresponding AS-1 and
AS-5 of the ICAI respectively.