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Practical Guide to Tax Audit - Rajkumar S. Adukia

Guidance on Form 3CD

11.1    Audit procedures

(a) Concept of materiality

The auditor should consider materiality and its relationship with audit risk when conducting an audit. Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item, judged in the particular circumstances of its misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which the information must have if it is to be useful.

The assessment of what is material is a matter of professional judgment. The auditor considers materiality at both the overall financial information level and in relation to individual account balances and classes of transactions. Materiality may also be influenced by other considerations, such as the legal and regulatory requirements, non-compliance with which may have a significant bearing on the financial information, and considerations relating to individual account balances and relationships. This process may result in different levels of materiality depending on the matter being audited.

So far as tax audit is concerned the materiality factor governs not only the audit reports in Form No. 3CA/3CB but also furnishing of particulars in Form No. 3CD.

(b) Obtaining detailed management representation

The tax auditor must obtain detailed management representations on all matters which are required to be considered and reported upon by him, while giving his tax audit report. He should obtain from the assessee, the statement of particulars in Form No. 3CD duly authenticated by the assessee.

However, the tax auditor should verify the particulars himself and cannot depend solely on the management representations.

(c) Audit under other sections of Income-tax Act vis-à-vis tax audit

Other sections of the Income Tax like 80IA (7) (deduction for undertakings engaged in infrastructure development) 80IB (13) (Industrial unit in a backward area, etc.) require accounts to be audited.

The audit report under section 80(IA)(7) and 80(IB)(13) is in respect of an industrial unit covered by the relevant provision whereas audit under section 44AB is in respect of an assessee covered by any of the clauses (a), (b) or (c).

The audit report should be Form No. 3CB in case the accounts of the assessee have not been audited under any other law such as Companies Act or Cooperative Societies Act etc. Audit under section 80(IA) or 80(IB) of the Income-tax Act will not be considered as audit under any other law. The requirement of section 44AB covers the overall position of the accounts of the assessee. It will apply to the accounts for the relevant year and include the results of all the industrial units of an assessee wherever they are located. Therefore, when the cumulative sales/turnover of all the units put together exceeds Rs. 40 lakh, the assessee will have to get the audit conducted under section 44AB and obtain the audit report in Form No. 3CB.

(d) Intimation of appointment or removal of tax auditor to Income-tax Officer

There is no provision under the Income tax to file the details or consent of the tax auditor under the Income-tax Act.

(e) Relying on the work of statutory auditor

Disagreement with the statutory auditor regarding treatment of personal expenses, valuation of stock, method of accounting, other matters covered under form 3CD etc.

The tax auditor has to attach a report of statutory audit if it has been carried under any other law by an auditor other than the tax auditor. He is not responsible for the particulars stated therein. His primary responsibility is verification of the particulars prescribed in Form No. 3CD and he should ensure that the particulars stated are in conformity with the provisions of the Income-tax Act.

However, while conducting tax audit he is unable to agree with the treatment given to a particular item in the audited financial statement, he should first ascertain preferably from the statutory auditor, the reasons for his giving such a treatment in his statement. It is possible that statutory auditor might have dealt with the item from the angle of generally accepted accounting principle or statutory provisions covering the entity.

The tax auditor should verify and ensure that particulars in respect of the above items are based on statutory provision and judicial pronouncements. However, any difference between the figures given in the audited financial statements and figures given in Form No. 3CD should be explained by giving appropriate notes. If, however, there is any difference in the opinion of the tax auditor and that of the entity in respect of any information furnished in Form No. 3CD, the tax auditor should state both the view points and also the relevant information.

(f) Accounts written in languages not familiar to the tax auditor

The tax auditor should not accept an assignment where the accounts are drawn up in a language which he does not understand, unless he can verify the authenticity either by himself or with the assistance of his audit staff. Special care has to be taken by him to ensure authenticity of the prescribed particulars being reported upon by him.

Qualifying audit report

(a) Non maintenance of stock records and /or no valuation of stock

If no stock records are made but physical verification is done on a regular basis the tax auditor need not qualify his report for non-maintenance of records. Valuation of stock needs to be on an acceptable method of inventory valuation. Valuation based on percentage of gross profit or any such arbitrary method should be reported and absence of stock records as well as physical verification would certainly call for appropriate qualifications by the tax auditor.

(b) If quantity records are not maintained by the assessee

In case quantitative records are not maintained, it will be difficult for the tax auditor to express an opinion whether the accounts give a true and fair view. Similarly, he will not be able to give the information required to be furnished against the relevant items in Form No. 3CD. He may therefore, have to qualify his report in appropriate cases.

In certain circumstances, it may not be possible to maintain day-to-day quantitative records having regard to the nature of business, like retail trade of small items The auditor can take into consideration the above circumstances and accept the explanation that it is not possible for the entity to maintain day-today stock records and in such a case he may not qualify his audit report. A suitable note to this effect can be put in the financial statements as well as against the relevant clause in Form No. 3CD.

(c) If the account books are not closed and closing entries are not passed

If the account books maintained by the assessee are not closed and the closing entries are not made, the auditor should ensure that this is done before he gives his audit report.

(d) If all expenses are debited to one expense account instead of bifurcating the expenditure under various heads

The tax auditor should ask the assessee to provide a break-up of the ‘miscellaneous expenditure’ to the extent relevant for his tax audit report.

(e) Difference in quantitative details of stock shown in the stock records with the quantity of closing stock stated in the statement submitted to the bankers (hypothecation account)


The tax auditor should make an enquiry on the reason for the difference and nature of variation and obtain a written explanation from the management. The tax auditor need not qualify his report when there are minor discrepancies and he is satisfied with the explanations. However, he should qualify his report when the discrepancies are material.

11.2    Clause-wise discussion

Note: The changes made in the new form 3 CD have been underlined.


Clause 1: Name of the assessee

a)      Provide the name of the assessed, correct and full name should be given.

b)      Incase of companies and firms to the extent possible acronyms should be avoided.

c)      In case of a branch, write name of branch along with name of assessee.

d)      If assessee is a proprietor give the name of the firm along with the name of the proprietor.

e)      In case there is a change in the name, proof of such change should be attached.

Clause 2: Address

a)      Provide the address from where the assessee conducts the business.

b)       In case of company, address of registered office must be given.

c)      In case of branch, address of branch should be given.

d)      Care must be taken that the same address is communicated to the Income tax department for assessment purposes.

e)      Incase of more than one place of business, address of such place should be given where correspondence related with income tax dept. can be sent to a person who has been authorized in this behalf.

Clause 3: Permanent Account Number

a)      The permanent account number has to be mentioned.

b)       If the application is pending, the fact should be mentioned along with the GIR No.

Clause 4: Status

a)      Status of the assessee as per section 2(31) of the Income Tax Act 1961, should be mentioned.

As per section 2(31) of the Income Tax Act 1961 person includes:

                    i.            An individual.

                  ii.            A Hindu undivided family.

                iii.            A company.

                iv.            A firm.

                  v.            An association of persons or a body of individuals, whether incorporated or not.

                vi.            A local authority.

              vii.            Every artificial juridical person, not falling within any of the preceding sub-clauses.

[Explanation: For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains.]

b)      Status here does not refer to residential status.

Clause 5: Previous year ended

a)      Previous year should be mentioned as per section 3 of the Income Tax Act 1961, i.e. ending on 31st March.

b)      In case of a newly set up business or profession, previous year will be beginning on the date on which it is set up and ending on 31st March.

Section 3 of the Income Tax Act 1961 is reproduced below:

For the purposes of this Act, previous year means the financial year immediately preceding the assessment year:

Provided that, in the case of a business or profession newly set up, or a source of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession or, as the case may be, the date on which the source of income newly comes into existence and ending with the said financial year.

Clause 6: Assessment year

a)      Assessment year relevant to the previous year for which audit has been done should be stated.

b)      Section 2(9) of the Income Tax Act, 1961 defines ‘Assessment year’ to mean the period of twelve months commencing on the 1st day of April every year.


Clause 7

a)     If firm or Association of Persons, indicate names of partners/ members and their, profit sharing ratios.

b)     If there is any change in the partners or members or in their profit sharing ratio since the last date of the preceding year, the particulars of such change.

Sub-clause (a)

a)      Mention the name of partners with profit sharing ratios and loss sharing ratios, if they are different.

b)      Remuneration to partners is not required to be mentioned.

c)      If as per the partnership deed there are separate ratios for sharing profits and losses both are to be mentioned separately.

d)      In case where the partner of a firm or member of AOP acts in as a representative capacity, the name of the member/beneficial partner is to be reported.

Sub-clause (b)

a)      If there is any such change since the last date of the preceding year must be stated. All the changes occurring during the entire previous year must be stated.

b)      It is to be noted that any change in remuneration affecting profit and loss ratios between partners/members need not be reported under this clause.


        i.          What is the date with reference to which the information in subclause (a) is to be given? Is it on the first day of the previous year or last day thereof?

The details of partners or members during the entire previous year will have to be furnished. Hence, the names of partners of the firm or members of the association of persons and their profit sharing ratios during the entire previous year will have to be stated and not merely on the first day of the previous year or last day thereof.

      ii.          What particulars need to be mentioned?

Particulars of any changes in the partners of the firm or members of the association of persons or their profit or loss sharing ratio must be stated. This would include the date of change in the membership of partner(s) of a firm or member(s) of an association, change in the profit sharing ratios (including changes, if any, in the terms of remuneration, interest), remuneration, etc.

Clause 8

a)     Nature of business or profession (if more than one business or profession is carried on during the previous year, nature of every business or profession).

b)     If there is any change in the nature of business or profession, the particulars of such change.

Sub- clause (a)

        i.          The principal line of business should be stated along with the nature of business.

      ii.          With regard to the nature of business, the principal line of each business such as manufacturing of consumer durables, trading in chemicals, and wholesale trade in textiles should be stated.

    iii.          If there are more than one type of business, then particulars for all should be stated.

    iv.          In case of a person rendering services, the nature of each type of service should be broadly stated.

      v.          Part B of the Annexure I to Form 3CD also requires information on nature of business. This Annexure provides details of various sector and sub-sector in which an assessee could be engaged. Information has to be furnished in respect of each business.

    vi.          Hence care should be taken that information provided under this clause should be in consonance with the information provided in Part B of Annexure I.

Sub-clause (b)

If there is any change in the nature of business or profession, the particulars of such change.

        i.          Any material change in business should be precisely stated.

      ii.          If there is any discontinuation line of business that should also be stated.

    iii.          The change will include change within the sector or change within sub sector as given in Part B of Annexure I.

    iv.          Even business or profession closed at the end of the year is required to be stated.

Clause 9

Sub-clause (a) whether books of account are prescribed under section 44AA, if yes, list of books so prescribed.

This clause is applicable to specified professionals Every person carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or authorized representative or film artist whose total gross receipts in the profession exceeds one lakh fifty thousand rupees in any one of the three years immediately preceding the previous year, or, where the profession has been newly set up in the previous year, and his gross total receipts in that year is likely to exceed Rs. 1,50,000 shall keep and maintain the books of account and other documents as follows.

        i.          A cash book.

      ii.          A journal, if the accounts are maintained according to the mercantile system of accounting.

    iii.          A ledger.

    iv.          Carbon copies of bills, whether machine numbered or otherwise serially numbered, wherever such bills are issued by the person, and carbon copies or counterfoils of machine numbered or otherwise serially numbered receipts issued by him.

Provided that nothing in this clause shall apply in relation to sums not exceeding twenty-five rupees (Rule 6F).

Additional requirements for medical profession.

A person carrying on medical profession shall, in addition to the books of account and other documents specified keep and maintain the following, namely:

        i.          A daily case registers in Form No. 3C;

      ii.          an inventory under broad heads, as on the first and the last day of the previous year, of the stock of drugs, medicines and other consumable accessories used for the purpose of his profession.

It may be noted that daily case register and inventory under broad heads do not constitute books of Accounts and need not be reported under this clause.

No book of accounts have been prescribed so far in respect of any other class of persons carrying on business or profession.

Sub-clause (b): Books of account maintained

(In case books of account are maintained in a computer system, mention the books of account generated by such computer system.)

        i.          Obtain a list of books of accounts from the assessee. In case books of account are maintained in a computer system, mention the books of account generated by such computer system and obtain a printout for the same.

      ii.          Assessee engaged in trading/manufacturing activity should maintain quantitative details of raw material, finished goods, stores etc.

    iii.          It may be noted that Clause 9(a) is applicable to only to specified profession as mentioned in Section 44AA. But clause 9(b) is applicable to all types of assesees.

Sub-clause (c): List of books of account examined

        i.          Give a list of accounts examined .if any books could not have been examined due to non-availability, the fact should be stated.

      ii.          When books are maintained in the computer systems, printouts of relevant accounts need to be taken.

    iii.          It may be noted that Clause 9(a) is applicable to only to specified profession as mentioned in Section 44AA. But clause 9(c) is applicable to all types of assesees.

The list of books of accounts prescribed, maintained and examined has to be stated under this clause. There may be difference between the 3 lists. For example, books of accounts may have been prescribed but all the prescribed books might not have been maintained or the entire books of accounts maintained might not have been produced for examination. The tax auditor should exercise his professional judgment and skill in order to arrive at the conclusion whether such a situation warrants any disclosure or qualifications while forming his opinion on the matters covered by reporting requirements in Form No. 3CB.

Clause 10

Whether the profit and loss account includes any profits and gains assessable on presumptive basis, if yes, indicate the amount and the relevant section (44AD, 44AE, 44AF, 44B, 44BB, 44BBA, 44BBB or any other relevant section).

        i.          If the profit and loss does not include the profit and gains assessable on presumptive basis this clause is not applicable.

      ii.          Auditor is required to mention the amount.

    iii.          Details of the relevant sections discussed in the clause are as follows.