UNIT III
SPECIAL AREAS OF AUDIT
Cost audit may be defined as “the verification of cost records and accounts and a check on the adherence to the prescribed cost accounting procedures and the continuing relevance of such procedures.”
Smith and Day in their book ‘Advanced Cost Accountancy’ define it, “the term ‘Cost Audit’ is meant the detailed checking of the costing system, technique and accounts to verify their correctness and to ensure adherence to the objective of cost accountancy.”
A cost audit, therefore, includes verification of correctness of cost accounts, cost statements, cost reports, cost data and costing techniques applied and finally checking these data to see that they adhere to cost accounting principles, plans, procedures and objectives.
The features of cost audit are:
It helps an organization to evaluate what costs are helping in profit creation and what is not. Hence, a company can understand in what areas it should spend its costing.
2. FORMULATE FUTURE STRATEGIES
Pre planning is one of the crucial aspects of every company as they do it always. But your planning is incomplete without having an understanding of the financial state of your company which is possible when you are aware of all costs, where to spend and where to not. Cost audit helps to keep a check on the increasing costs as well as to remove all those sections which are not profitable even when the cost is applied.
3. EASY BUDGETING
No business can move towards success without budgeting. The cost accounts report of past years helps you to create your future budget plans. Hence, proper budgeting can be done in a company by using a cost audit.
4. IDENTIFICATION OF BREAK EVEN POINT
Earning profit is a key reason to start a business but earning profits is not easy in the starting days. In the beginning they have to reach their break-even point. Cost audit can give the exact calculation of all the expenditures which you can compare with your profits.
5. REDUCE OVERHEAD COSTS
By evaluating the overhead costs with cost audit, these costs can be reduced as per the requirement.
Key Takeaways:
1) A cost audit includes verification of correctness of cost accounts, cost statements, cost reports, cost data and costing techniques applied and finally checking these data to see that they adhere to cost accounting principles, plans, procedures and objectives.
In case the turnover of the taxpayer (irrespective of its category) is equal to or more than Rs. 1 Crore from the business or Rs. 50 Lakhs from the income from profession then as per The Income Tax Act, 1961 an audit known as Tax Audit by a practicing chartered accountant (CA) is required to be done under section 44AB. The tax audit report must be filed online at the income tax portal before 30th September of the assessment year.
Tax Audit is an independent audit by a chartered accountant in full-time practice concerning the matters related to Taxation only and a report confirming that there is no concealment of income by the taxpayer and that there is no non-payment of tax liability and the same has been paid on due dates. The tax audit is a statutory obligation on the part of the taxpayer and is applicable on all cases where the turnover or the gross receipts during the previous year is more than the limit prescribed under section 44AB for the respective assessment year. The due date for filing the tax audit report is 30th September of the assessment year. In case the audit report is not submitted within its due date then the taxpayer is required to pay a penalty of an amount equal to 1.5% of the gross receipts/turnover, however, subject to a maximum fine of Rs. 1.5 lakhs.
We present the various categories of taxpayers below:
Category of person | Threshold |
Business | |
Carrying on business (not opting for presumptive taxation scheme*) | Total sales, turnover or gross receipts exceed Rs 1 crore in the FY |
Carrying on business eligible for presumptive taxation under Section 44AE, 44BB or 44BBB | Claims profits or gains lower than the prescribed limit under presumptive taxation scheme |
Carrying on business eligible for presumptive taxation under Section 44AD | Declares taxable income below the limits prescribed under the presumptive tax scheme and has income exceeding the basic threshold limit |
Carrying on the business and is not eligible to claim presumptive taxation under Section 44AD due to opting out for presumptive taxation in any one financial year of the lock-in period i.e. 5 consecutive years from when the presumptive tax scheme was opted | If income exceeds the maximum amount not chargeable to tax in the subsequent 5 consecutive tax years from the financial year when the presumptive taxation was not opted for |
Carrying on business which is declaring profits as per presumptive taxation scheme under Section 44AD | If the total sales, turnover or gross receipts does not exceed Rs 2 crore in the financial year, then tax audit will not apply to such businesses. |
Profession |
|
Carrying on profession | Total gross receipts exceed Rs 50 lakh in the FY |
Carrying on the profession eligible for presumptive taxation under Section 44ADA | 1. Claims profits or gains lower than the prescribed limit under the presumptive taxation scheme 2. Income exceeds the maximum amount not chargeable to income tax |
Business loss | |
In case of loss from carrying on of business and not opting for presumptive taxation scheme | Total sales, turnover or gross receipts exceed Rs 1 crore |
If taxpayer’s total income exceeds basic threshold limit but he has incurred a loss from carrying on a business (not opting for presumptive taxation scheme) | In case of loss from business when sales, turnover or gross receipts exceed 1 crore, the taxpayer is subject to tax audit under 44AB |
Carrying on business (opting presumptive taxation scheme under section 44AD) and having a business loss but with income below basic threshold limit | Tax audit not applicable |
Carrying on business (presumptive taxation scheme under section 44AD applicable) and having a business loss but with income exceeding basic threshold limit | Declares taxable income below the limits prescribed under the presumptive tax scheme and has income exceeding the basic threshold limit |
Who can conduct tax audit under section 44AB?
Tax audit can be conducted by a Chartered Accountant who holds the certificate of practice and is in full-time practice. However certain classes have been defined who cannot conduct tax audit under section 44AB. The tax auditor (CA) carries out a systematical examination of books of account as per the formats prescribed by the department.
Who has to get tax audit under section 44AB done?
Every person who derives income by way of Business or profession and maintains books of accounts and has not opted for computation of income on presumptive basis under section 44AD, 44ADA or 44AE of the Income-tax Act, 1961 has to get tax audit done provided his income exceeds the prescribed threshold limit. The following person are required to get tax audit done in the given cases.
1. A person carrying on business if the total sales/ turnover exceeds Rs. 1 crore during the previous year relevant to assessment year.
2. A person carrying on profession if the Gross receipts exceeds Rs. 50 lakhs during the previous year relevant to assessment year.
Also, the person who has opted for computing profits and gains of business on presumptive basis under section 44AD earlier and 5 years have not lapsed since then but the assessed has opted out of such presumptive income and his income exceeds the ceiling for chargeability of income tax, is also required to get tax audit done.
Further where a person has opted for presumptive scheme under section 44ADA and he claims his income lower than the deemed profits and his income exceeds the ceiling for chargeability of income tax, is also required to get tax audit done.
Tax audit is also mandatory for the assesses opting for presumptive scheme under section 44AE, 44BB and 44BBB and claiming income lower than the deemed profits.
However, if the assessed is liable/ required to get his books of accounts audited under any other law (let’s say Statutory audit as per the provisions of Companies Act, 2013), in such a case, he is also required to get tax audit done because When an Act requires a person to get his accounts audited, it does so with an objective. The audit carried out under any Act (e.g., a statutory audit under Companies Act) does not provide the confirmation if provisions of the Income-tax Act have been properly complied with. The Income-tax Authorities need confirmation whether the tax provisions have been properly applied by an assessed, and it can be done only through a tax audit.
Objectives of the Tax Audit:-
It is a special of tax audit that it depends on the basis of income tax law provisions more than it depends on accounting standards. The main objective for tax audit, it is to compute the taxable income according to the income tax law, and there are some other objectives:-
Key Takeaways:
1) Tax Audit is an independent audit by a chartered accountant in full-time practice concerning the matters related to Taxation only and a report confirming that there is no concealment of income by the taxpayer and that there is no non-payment of tax liability and the same has been paid on due dates.
2) Tax audit indicates and checks fraudulent practices in final accounts.
A management audit is an analysis and assessment of the competencies and capabilities of a company’s management in carrying out corporate objectives. The purpose of a management audit is not to appraise individual executive performance but to evaluate the management team in its effectiveness to work in the interests of shareholders, maintain good relations with employees and uphold reputational standards.
A company’s Board of Directors does not have a formal management audit committee. Instead, board members sit on the compensation committee and assess the performance of individual executives using quantitative information (organic sales, EBIT margins, segment margins, operating cash flows and EPS) and unquantifiable or intangible elements (e.g. effort towards acquisition integration).
The BOD would hire an independent consultant to conduct a management audit. The scope of audit may be narrow, but in most cases, it is comprehensive including many key aspects of the responsibilities of the management team.
It is highly desirable that the auditor obtains a sufficient understanding of the client’s internal controls (I/C) to plan the audit and assess control risk. If on assessment the control risk is showed to be low, the auditor can reduce substantive testing. When EDP is used in significant accounting applications, then the auditor must consider the effects the computer has when evaluating the internal controls. The auditor’s approach to considering I/C is the same in a computerized environment as in a manual environment:
(A) Obtain and document understanding of the internal controls
(B) Assess control risk
(C) Perform tests of controls
(D) Reassess control risk
(A).Obtain and document an understanding of the I/C. The extent to which the auditor needs to understand the computer system is dependent upon the preliminary audit strategy selected:
(a) Primarily substantive approach--treat computer as a black number crunching box and just audit the inputs and outputs (auditing around the computer)
(b) Lower assessment of control risk--you rely on the computer’s controls (audit through the computer)
(B) Assess Control Risk. The auditor needs to assess the risk that the internal controls (including EDP controls) will not prevent or detect material errors or irregularities that will effect the financial statements.
(a) The Auditor considers the strengths and weaknesses of the general controls first. Example of this in the Advances Module — One of the application (programmed) controls requires authorization from a officer before an Cash credit account can overdraw above the drawing limit fixed. However, if the general controls over changes to programs cannot be relied on, then the advances module could be modified to allow an unauthorized clearing. Thus, the application control could not be relied on either.
(b) Identify the general controls on which the auditor plans to rely.
(c) Consider the strengths and weaknesses of application controls and user controls next.
(d) Identify the application and user controls on which the auditor plans to rely. Now the auditor should make an initial assessment of whether the EDP controls appear reliable. He can :
1. Determine if the EDP controls do not, after detailed review, appear reliable, the audit objectives can be achieved by other means (AUDIT AROUND THE COMPUTER if possible) OR
2. Determine EDP controls appear reliable & move to tests of controls (C) Tests of Controls (TCs) in Computer Environment The purpose of TCs is to obtain reasonable assurance that the internal controls are functioning properly. The general controls are tested first, then the application and user controls. The TCs are done on a cycle by cycle basis. So the deposit module will be tested separately from the advances module (and so on). The Auditor does this because the controls in each cycle are different and independent. (D) Reassess control risk based on results of TCs
(1) High control risk would necessitate greater dependence on substantive testing and low reliance on computer controls.
(2). Low control risk means the computer controls can be relied upon to produce better & thus substantive testing can be reduced.
(3) No matter how good controls are some substantive testing should be done. The areas that can be covered in audit under EDP environments are as under:
(1) Business Strategy.
(2) Long Term IT Strategy.
(3) Short Range IT Plans.
(4) IS Security Policy.
(5) Implementation of Security Policy.
(6) IS Audit Guidelines.
(7) Acquisition and Implementation of Packaged Software.
(8) Development of software - in-house and outsourced.
(9) Physical Access Controls.
(10) Operating System Controls.
(11) Application Systems Controls.
(12) Database controls.
(13) Network Management.
(14) Maintenance.
(15) Internet Banking.
In order to facilitate understanding of the scope and authority of the pronouncements of the Auditing and Assurance Standards Board ('AASB'), the ICAI has issued revised preface viz., Preface to Standards on Quality Control for Auditing, Review, Other Assurance and Related Services, which has come into effect from 1st April, 2008. Standards of the following nature issued by the AASB shall be collectively known as 'the Engagement Standards':
Auditing and Assurance Standard ('AAS') have been re-numbered and classified in the above five categories as Standards on Auditing.
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