Methods of Investigations of Books of Accounts & Other Documents

Book Details

Chapter 1 Introduction	1
Loose-leaf Account Books	2
Preliminary decisions in questionnaire design	2
Deciding on the information required	2
Chapter 2 — Different Stages of Evolution of Money	�
Metallic Money	8
Paper Money	8
Credit Money	8
Electronic Money	9
Plastic Money	9
History of Indian Rupee	9
Chapter 3 — Maintenance of Books of Account by Certain Persons Engaged in Specified Professions or Businesses [Section 44AA]	12
Meaning of the Term “Books�	12
Preparation of Financial Statements	13
Voucher Maintenance and Supporting Documents	13
What are the Prescribed Books?	14
Who is required to maintain books of accounts?	14
Specified Professions	15
Non-Specified Professions	15
Business eligible for presumptive taxation scheme under Section 44AD, 44AE, 44BB, or 44BBB	15
Other Business	16
Which books of accounts are required to be maintained?	16
Where books of account and other documents should be kept and maintained?	17
Period of maintenance	17
Penalty for non-compliance [Section 271A]	17
Chapter 4 — Maintenance of Books of Account and other Documents by Persons Carrying on Certain Professions[Rule 6F of the Income Tax Rules, 1962]	20
Maintenance of Books of account and other documents by persons carrying on certain professions	20
Chapter 5 — Maintenance of Books of Account and other Documents by Trusts or Institution [Rule 17AA of the Income Tax Rules, 1962]	23
Books of Accounts and Other Documents required to be maintained	29
Mode in which Documents may be Kept	30
Consequences of failure to maintain	32
(i) Denial of Tax Exemption under sections 11 and 12:	32
(ii) Best Judgment Assessment under section 144:	32
(iii) Cancellation of Registration:	32
(iv) Penalty under Section 271AAD:	32
(v) Imprisonment under Section 276D:	32
Chapter 6 — Method of Accounting	33
What is Method of Accounting	33
Methods of Accounting Recognized	34
Apex Court’s Observation on recognized methods	34
Choice and Change in the Method of Accounting	34
Assessee has the choice on method, but such method should be shown as regularly followed	35
Benefits of Cash system	36
Chapter 7 — Defective, Duplicate or No Accounts Cases	84
Where does one find such cases?	84
No account case : Action points for Assessing Officer	84
Computation of profit in no account cases	85
Investment method or increase in capital method	85
Cash Flow and Investment	88
Estimation of Profit Method	89
Where Entire Unaccounted Sales are Treated as Income	89
Where Gross Profit is Estimated	89
Where Net Profit is Estimated	90
Peak Credit as an alternative to Estimation of Income	91
Double additions to be avoided: the investment and the source	92
Chapter 8 — Examination of Books of Account	93
Identification of books of account	93
Account books	93
Journal	93
Sales/Purchase Register	94
Identification of Debit and Credit Sides	94
Finding out Method of Accounting	94
Comparison with Back Records	94
Points which should be examined	95
Chapter 9 — Generating Undisclosed Income by Manipulation of Accounts	96
Manipulations of Accounts for Tax Evasion	96
(1) Out of Book Transactions	96
(2) Manipulation of Books of Account	97
(3) Under-reporting of Production	99
(4) Other Manipulations of Accounts	99
(5) Manipulation by way of International Transactions through Associate Enterprises	99
(6) Manipulation of Capital Expenses	99
Chapter 10 — Manipulation of Books of Accounts	100
In the Books of Accounts	100
Outside the Books of Accounts	100
Manifestation of Concealed Income/Unaccounted Funds	100
Qualities in order to achieve the best results	100
(a) Inflation of Purchases	101
(b) Suppression of Sale	101
(c) Inflation Cost of Production:	101
(d) Suppression of Production:	102
Manipulation of closing stock	102
Chapter 11 — Examination of Manufacturing Account	103
Inflation Cost of Production	105
Suppression of Production	105
Manufacturing expenses	105
Manufacturing Expenses and Direct Expenses	105
General particulars of Manufacturing Activity	106
Opening Stock	107
Purchases	107
Average Input	107
By raising bogus purchase bills	109
Manufacturing Expenses	109
Stores	110
Miscellaneous Expenses - repair expenses etc.	111
Production Records	111
Output ratio of main raw materials and main finished goods	112
Circumstances of sudden or violent fluctuation in prices	112
By-products of the production process	112
Analysis of input-output ratios and stock account	113
Whether the quantity of raw material consumed, is correctly reflected in the books of accounts or not ?	113
If the assessee is having a key-loan account	114
Minimum holding of raw materials	114
Examination of Stock Account where Driage is Claimed	114
Stock Tally Given by the Assessee	115
Chapter 12 — Examination of Trading Account	117
Disclosure requirements under AS - 17	117
Method of constructing Quarterly trading account:	120
Manipulations in Trading Accounts	121
Chapter 13 — Examination of Profit & Loss account	123
Format of Profit and Loss Account	123
Credit side of Profit and Loss or Income & Expenditure Account :	124
Common issues involved while examining the Profit and Loss account	125
[i] Whether any capital expenditure is debited as revenue	125
[ii] Whether any personal expenditure is debited in the guise of business expenditure	125
[iii] Whether any expenditure incurred for any purpose which is an offence or which is prohibited by law;	125
Points for verification of various items of expenses in the Profit and Loss Account	126
Sales promotion/commission	128
Chapter 14 — Examination of Genuineness of Vouchers	135
Chapter 15 — Inflation of Expenses	136
Illustration (Bogus Purchases)	136
Chapter 16 — Verification of Gross Profit Rate (GP Rate)	137
Periodical Analysis of Purchase/Sales:	139
Common defects in Books	140
Estimating Fair G.P. Rate	140
To verify steep fall in Gross Profit rate	141
Chapter 17 — Net Profit Rate	146
Chapter 18 — Examination of Balance Sheet	156
Limitations of Balance Sheet	156
About Balance sheet	157
Non-Moving Debtors/Creditors	159
Preliminaries of Enquiry	159
Balance Sheet for the first year	160
Action point for Assessing Officer	160
Chapter 19 — Examination of Statement of Assets and Liabilities	165
(a) To compare the increase in assets with admitted income	165
(b) To detect bogus liabilities	165
(c) To detect under-valuation of assets	166
(d) To make assessee commit with regard to his capital, drawings, etc:	166
Chapter 20 — Share Capital	167
Share capital in light of section 68 of the Income-tax Act, 1961	167
Routing unaccounted money using listed paper companies,‘colorable device’ & fraud on Revenue	167
Chapter 21 — Share Application Money	177
Share application money pending for allotment of shares	177
Checklist for Verification	177
Chapter 22 — Share Premium in Excess of Fair Market Value to be Taxed as Income [Section 56(2)(viib)]	191
Share premium in excess of the fair market value deemed as income [Section 56(2)(viib)]	191
Background	191
Objective of the amendment to section 56(2)(viib)	192
Extract of object Memorandum of Finance Bill, 2012	192
Position after 31.03.2012	193
Applicability of clause (viib) to section 56(2)	195
Extension of exemption to Categories I & II AIF [clause (i) of Section 56(2)(viib) of the Income-tax Act, 1961 – Income from other sources — chargeable as — Start ups — Clarification with respect to assessment of startup companies involving application of said section of the Income-tax Act, 1961	212
Notified class of persons under clause (ii) of proviso to Section 56(2)(viib)	213
Notification No. SO 1131(E), dated 05.03.2019	213
Chapter 23 — Sundry Debtors (Trade)	241
Sundry Debtors (Receivables)	241
Investigations of Sundry Debtors, Loans and Advances	242
Sundry (trade) debtors is more than sales	242
Trade debtors’ balances remaining constant	243
Chapter 24 — Sundry Creditors (Trade)	244
Action point for Assessing Officer	244
Trade creditors’ balances remaining constant	244
When trade creditors finance/source fixed assets	245
Total purchases is less than Sundry (trade) Creditors	245
Chapter 25 — Loans, Advances and Deposits	246
Action points for Assessing Officer	246
Chapter 26 — Reserve & Surplus	247
Types of Reserves and Surplus	247
Share Premium Account	247
Sinking Fund:	248
Taxation Reserves	248
Subsidy Reserve	248
Revaluation Reserve	248
Debenture Redemption Reserve (DRR)	248
Examining Reserves	248
Origin of reserves should be examined	249
Action points for Assessing Officer	249
Chapter 27 — Secured Loans	250
Loans and Advances from Banks	250
Bank Loan	250
Action points for Assessing Officer	251
Chapter 28 — Unsecured Loans	252
All new cash credits should be examined	252
Loan Creditors:	252
Cash Credits/Benami Transactions	253
Action points for Assessing Officer	253
Chapter 29 — Investment	255
Action point for Assessing Officer	255
Disclosure Requirements:	255
Revaluation of Long Term Investments	256
Income from Investments:	256
Chapter 30 — Fixed Assets	257
Action point for Assessing Officer	257
Tangible Fixed Assets	257
Intangible Fixed Assets	258
Addition to Fixed Assets	259
Reduction in Fixed Assets:	259
Amalgamation/Merger/De-merger	259
De-merger	259
Capital Expenditure v. Revenue Expenditure	259
Capital Work-in-Process (CWIP)	260
Chapter 31 — Depreciation	261
Written Down Value of block of assets	262
Mis-use of Depreciation Provisions	262
Multiple Financing	262
Existence/Genuineness of Depreciable Assets on which Higher Rate of Depreciation is Allowed:	262
Excess Claim of Depreciation	262
Multiple Dip	263
Off-Balance Sheet Fixed Assets	263
Chapter 32 — Liabilities	264
Capital Structure of Companies	264
Types of Shares:	264
Altering Share Capital	264
Bonus Shares:	265
Share Application Moneys	265
Redemption of Redeemable Preference Shares	265
Conversions	265
Conversion of Partnerships into Companies	265
New Share Capital:	265
Shares-in-kind	266
New Financial Instruments—Deferred Capital	266
Capital introduction—Section 68	267
Building Capital through Circular Transactions	267
Introduction of Share Capital through Bogus/Paper Companies	267
Perpetual Non-Convertible Debentures (“PNCDs�) or Hybrid Bonds	267
Remission of liability	268
Chapter 33 — Current Liabilities	269
Acceptance	269
Sundry Creditors	269
Advance Payments and Unexplored Discount	269
Unclaimed Dividend	269
Chapter 34 — Contingent Liabilities	270
Provision for various contingent liabilities	270
Liability in respect of provision for warranty claims is not a contingent liability	270
Liability of Contingent nature - The present value of contingent liability, like warranty expense, if properly ascertained & discounted on accrual basis is allowable	270
Chapter 35 — Provisions	274
Provision for Taxation	274
Provision for Provident Fund and other Retirement Benefits	274
Provision for Contingencies	274
Provision for Loss in the Value of Investments	274
Action points for Assessing Officer	274
Chapter 36 — Examination of Cash Book	275
Format of Double Column Cash/Bank Book	275
What to examine in a Cash Book ?	275
[1] Cash credits	276
[2] Entries at the end of cash book	276
[3] Unledgerised entries	276
[4] Daily balancing of cash book	276
[5] Opening entries	277
[6] Cash credit and bogus sales	277
[7] Ante dating of receipts	277
[8] Cash Payments Exceeding 10,000/- (i.e., Section 40A(3) payments)	277
[9] Minimum, Maximum and Average Cash Balance	277
[10] Summary of all the Cash Payments	278
Daily balancing of cash book	278
Opening entries	278
Postponing entry of Cash deposited in the Bank	278
Inflating Receipt Side Total and Deflating Payment Side Total in Cash Book	279
Postponing Entry of Cash Deposited in the Bank	279
Chapter 37 — Negative Cash Balance	280
Chapter 38 — Examination of Day Book	282
Chapter 39 — Contra Entry	283
Chapter 40 — Cash in Hand	284
If cash on hand is less than cash balance as per cash book	284
Deficit cash and deficit stock	284
Deficit cash and no difference in stock	284
Conclusion on deficit cash:	284
Chapter 41 — Examination of Cash Flow Statement	285
Uses of Cash Flow Statement	286
Examination of Cash Flow Statement	286
Chapter 42 — Funds Flow Statement	288
Uses of Funds Flow Statement	288
Chapter 43 — Examination of Ledger	289
Format of Ledger Account	289
How to examine a ledger?	289
Bank A/c in the ledger should be compared with bank pass book	290
Chapter 44 — Verification of squared up accounts during the year	291
Verification of squared up accounts	291
Cash Credits/Benami Transactions	291
Chapter 45 — Trial Balance	293
Meaning & Definition of Trial Balance:	293
Action point for Assessing Officer	293
Chapter 46 — Examination of Journal	294
Points to look for in journals	294
Chapter 47 — Opening Stock & Closing Stock	295
Type of inventory	295
Action point for Assessing Officer	295
When inventory is produced	295
When inventory is not produced	296
Chapter 48 — Closing Stock	304
Closing stock can also be checked with reference to availability of storage space	307
Suppression of Closing Stock	308
Goods in Transit and Paid for:	308
Goods Sent to Customers for Approval:	308
Closing Stock at Branches:	308
Under-valuation of Closing Stock:	308
Overstatement of Closing Stock	309
Quantitative Details - Stock Register	309
Valuation of Inventories:	310
Important Points Regarding Valuation of Stocks	310
If actual quantity of physical stock is more than stock as per books	311
If actual quantity of physical stock is less than stock as per books	313
If actual value of physical stock is in excess of value as per books:	313
If actual value of physical stock is less than value as per books	314
Verification of correctness of closing stock value admitted in the return	314
Steep fall in closing stock value	315
Stock is equal to or at least 50% of turnover	315
Chapter 49— Verification of Purchases	316
Beneficiaries of bogus entry providers	316
Verification of Purchase Vouchers	317
Verification with Suppliers	318
Verification of Mode of Payment	318
Inflation of purchase	318
Post-dated Purchases and Expenses	320
Showing Cash Purchases as Credit Purchases	320
[1] Bogus Purchases	321
[2] Over Invoicing	321
[3] Over-Invoicing of Imports	321
[4] Earlier/Later Purchases Recorded	322
[5] Purchase of Inferior Quality Recording Superior Goods:	322
[6] Purchases Recorded at High Price Zone:	322
[7] Purchasing Non-Saleable Goods as Standard Goods and Subsequently Writing Off of Stock as Bad/Unsaleable, etc.	322
[8] Not Accounting Purchase Return:	322
[9] Miscellaneous Matters	323
Methods employed for inflating purchases	323
Inflation of Purchases	323
Purchases should also be checked with reference to direct expenses 324
Chapter 50 — Fictitious purchases	326
Action points for Assessing Officer	326
When an Assessing Officer is likely to find out about bogus transactions?	326
Linking of fictitious transactions	327
Chapter 51 — Bogus Purchases	329
Some common methods of introducing bogus purchases	329
Type of additions seen made in different cases of assessee	331
Chapter 52 —Verification of Sales	355
Enquiries from assessee	355
Action points for Assessing Officer	356
1. Sales Outside the Books:	357
2. Under Invoicing:	357
3. Excluding the Sales at the Beginning/End of the Year	357
4. Sale of Quality Goods Shown as Sale of Sub-Standard Goods	358
5. Sales Pushed to Low Price Zone:	358
6. Sales Return:	358
Mode of Payment	358
Sales at Lower Rates to Nominees	358
Miscellaneous	359
Verification with Contract Notes	359
Suppression of Sale	360
Where Entire Unaccounted Sales are Treated as Income	360
Chapter 53 — Understatement of Sales by Suppression	361
Chapter 54 — Fictitious Sales	363
Sales to a Fictitious and Non-Existent Concern	363
Chapter 55 — Treatment of Cash Sales	365
No law which prohibits a trader or a manufacturer in making cash sales	365
Showing Fictitious Cash Sales or Speculation Profits	365
Cash credit and bogus sales	365
Showing Fictitious Cash Sales or Speculation Profits	365
Cash Sale – Tax provisions	366
Non-Applicability of section 269ST	366
Penalty	367
CBDT Circular No. 27/2017, Dated 03.11.2017	367
Chapter 56 — Unaccounted Purchases & Sales	371
Chapter 57 — Trade/Cash Discounts	376
Comparison between trade discount and cash discount	376
CBDT Circular No. 12 of 2022, Dated 16.06.2022	376
Chapter 58 — Consignment Account Meaning of Consignment Account	378
Account for goods that is sent to a person or company that is not the owner but is responsible for selling them or returning them to the owner if they are not sold: The value of the goods that are sent on consignment are charged to the consignment account	378
Accounting of Consignment Sale	379
Consignment Sale in Pre-GST Period	380
Consignment Sale under GST Regime	380
Points for Verification	381
Chapter 59 — Bogus Capital Gains from Penny Stocks	384
What are penny stocks?	384
Background	384
Results of Kolkata Investigations [Investigation Report of the Directorate of Income Tax (Investigation) Kolkata, in case of Project Bogus LTCG through BSE Listed Penny Stocks]	385
SEBI Investigation and ban	385
Types of penny stock companies	386
Method of Transaction	386
1. Conventional method	386
2. Merger method	386
Modus operandi as per Investigation report	387
Entities involved in the transactions	389
Bogus capital gains from Penny stocks	390
Assessee needs to maintain and produce following documents/evidence to prove the genuineness of the share transaction	390
Basic Documents	390
Action Point for Assessing Officer:	391
Gathering the information available in public domain:	392
Information to be collected from assessee:	392
Information to be gathered from other sources:	393
Collect all the informations and summoning the Assessee	394
Specimen of Summons under Section 131	395
Tax Rates [As per Section 115BBE]	396
Standard Operating Procedure (SOP) issued by the Department to Handle Cases of Bogus Long-term Capital Gain/Loss Mainly Penny Stock	397
Steps taken by the Government	397
Chapter 60 — Investigation of Bank Accounts	424
Records kept by Banks	424
Account Opening Forms	424
Locker Register	425
Fixed Deposit Register	425
Clearing Register	425
OBC Register	425
Slip Bundles	425
Types of Bank Accounts	425
Saving Bank Accounts:	425
Current Accounts:	425
Cash Credit Accounts:	426
Fixed Deposit Accounts:	426
Deposits in Bank Accounts	426
Withdrawals from bank accounts	427
Types of Cheques:	427
Follow-up of Cheques	430
Introduction of unaccounted cash as Cash Credit	432
Debit on Account of Bank Charges	433
Other Similar Clues	433
Tracing of Secret Bank Accounts	434
Remittances of secret T.T./D.D. in Benami Names	434
Discounting of Bills	435
Analysis of Foreign Exchange Transactions	435
Verification of Credit Card Slips	436
Tax Evasion using Networked Systems of Banking	436
Bank balance:	437
Chapter 61 — Examination of Bank statement	438
Action points for Assessing Officer	438
Chapter 62 — Cash Deposits found in Banks	440
Consequences if any money found deposited in bank statements for which no valid explanation about the nature and source of the cash, or if the assessing officer is not satisfied with the explanation provided	440
(i) Imposition of tax under section 115BBE	440
(ii) Penalty under section 271AAC	440
(iii) Penalty under section 270A [For other additions, i.e., other than additions made under sections 68 to 69D]	441
Cash in hand- Test to be satisfied	441
Cash Sale – Tax provisions	441
Chapter 63 — Deposit Found in Foreign Bank Account	479
Chapter 64 – Drawings	484
Action points for Assessing Officer	484
Chapter 65 — Peak Credit Theory	485
Theory of Peak Credit	485
Chapter 66 — Theory of Telescoping in Determining the Taxability of Undisclosed Income	490
What is theory of Telescoping	490
Telescoping	490
Brief background of Telescoping	491
Manner of application of the theory of telescoping	492
Chapter 67 — Surrounding Circumstances and Test of Applying Human Probabilities	507
Suspicious and dubious transaction how to be dealt with	507
Circumstantial evidence how to be used	507
Surrounding circumstances and test of applying human probabilities	508
Chapter 68 — Ratio Analysis	525
Step 1	525
Step 2	525
Step 3	525
Step 4	525
Major Reasons of Deviations	525
[1] Acid Test or Quick Ratio:	526
[2] Stock Turnover Ratio:	526
[3] Debtor’s Turnover Ratio:	526
[4] Creditor’s Turnover Ratio:	527
[5] Debt Capital Ratio:	527
[6] Gross Profit Ratio:	527
[8] Expenses Ratio:	528

About the Author

Ram Dutt Sharma

Ram Dutt Sharma was born on 27th June, 1958 in Narnaul, Haryana. He got his post-graduation from M.D. University, Rohtak in 1980. He joined the Income-tax Department in the year 1983 and retired as Income Tax Officer on 30.06.2018. He worked at various stations of North-West Region of Income-tax Department. He has wide experience of all wings of Income-tax Department such as Assessment Unit, Special Range, TDS Wing, Investigation Wing, etc. He has been Contributing articles and addressing on topics relating to Income Tax at NADT Regional Campus, Chandigarh & Bhopal. He has also addressed number of seminars organized by the Income-tax Department, Chartered Accountants, Advocates and various Trade Associations.

He is recipient of first-ever Finance Minister's Award 2017, the Income Tax Departments highest honour for sustained devotion, commitment to duty & promoting excellence in the field of Direct Taxation at National Level. The Hon'ble Union Finance Minister, Shri ArunJaitley conferred this Finance Ministers Award for Excellence for his meritorious services at VigyanBhawan, New Delhi on 24.07.2017.

Awarded by Hon'ble Member (Revenue& TPS), CBT, Special Secretary to the Government of India Certificate of Appreciation for his contribution recognized and included in the chapter Miscellaneous Orders in Let Us Share A compilation of Best Practices & Orders Vol. VIII released on 31stOctober, 2016.

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