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TMI BlogBuilding knowledge on financial accountingX X X X Extracts X X X X X X X X Extracts X X X X ..... ed annual financial statement in FORM GSTR 9C/any other form, etc.; - Such other particulars, as may be prescribed. 9.2.2 Audit in GST with reference to financial accounting a. While implementing the GST Law, the GST officers come across the financial accounts of the taxpayer. Taxpayers' business consists basically of his daily transactions of outward or inward supplies (alongwith events related to such supplies), and each transaction may have GST implications i.e. either levy of GST or the claim of legitimate and eligible ITC or the GST by way of RCM. Hence, the GST officers are required to have a working knowledge of financial accounting, on the basis of which entire business transactions are recorded and compliance is made by the taxpayer. b. GST audit casts a huge responsibility on the auditor for detection of tax not paid or short paid or erroneously refunded, or input tax credit wrongly availed or utilized etc. Hence, it is very important that the auditor possesses a good understanding of accounting fundamentals as well as sufficient accounting skills to read and analyze financial statements. Further, there are several transactions which may not appear in the financial a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... audit, and the one appropriate to the financial accounting must be chosen or designed for the auditor. e. In this context, it is relevant to note that the importance of evaluating the internal control mechanism of the entity under audit cannot be overemphasised. Evaluation of the internal control system is a very important step in the actual conduct of audit as it enables drawing of correct samples for auditing and effective targeting of risk areas. Internal control mechanism is actually the sum total of all policies and procedures which are adopted by the entity in order to achieve the objective of "orderly and efficient conduct of its business", including safeguarding of assets, prevention and timely detection of any fraud/error, ensuring accuracy and completeness of recording, classification and disclosure of transactions. f. Essentially, the efficacy and effectiveness of the internal control mechanism of the auditee provides a reasonable assurance to the auditor as to the degree of reliance that can be placed on the accounts and financial statements of the auditee. Based on his/her assessment of the effectiveness of such a mechanism the auditor can draw appropriate samples f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, transfer, barter, exchange, rental, lease, disposal, stock-transfer etc. of goods and/or services. * On the contrary, in 'financials' revenue is recognized when the goods are sold, or services are rendered. No revenue is recognized when the fixed assets are sold / disposed of, except for profit on sale of such assets or when goods are transferred to the branches. * For instance, from an accounting standpoint, revenue from sale of goods is recognized when significant risks and rewards in the goods is transferred by the seller to the buyer while in case of services revenue is recognised either on proportionate completion method or completed service contract method. These events may not correspond to the time of supply set out in sections 12, 13 and 14 of the Act and, accordingly, revenue as per the books of accounts may differ with that under GST law. * This leads to the concept of billed/unbilled revenues and prior period items. 9.2.4 Value of Supply recognition from a GST perspective * Such transactions would result in difference between the revenue reported under GST when compared to the 'financials'. * Value of supply of goods or services or both under Section 15 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hether all supplies to external entities have been reflected in the return. * Further, it can also help GST officer to understand the working of a business and its operations. It provides them with details about the business' cash flow, from where is it coming and where it is going. Cash flow is the indicator of the Taxpayer's financial well-being, its liquidity, and its operating ability. * The GST officer needs to calculate and reconcile the Receipts disclosed and find out and confirm that they are appropriately disclosed and subjected to tax. 9.2.6 Sector specific approach Some sectors involve complex income streams, financial reporting mechanisms etc., of which officers may not always be fully conversant. For example, various income/revenue heads often need to be verified by the officers during audit of Banking, Insurance and Non-Banking Financial Companies (NBFC) sectors. The Banking sector generates income among others through interest income, capital markets operations (e.g., sales and trading services, underwriting services, mergers & acquisition advisory), other fee-based income (e.g., credit card fees, savings/ current accounts charges, mutual fund revenue, investme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 9.2.8 Interpreting Business Contracts/Agreements a. A business contract/agreement is the statement, either oral or written, of an exchange of promises in business. It is a negotiated and legally enforceable understanding between two or more legally competent parties. b. There are different types of business agreements/contracts. Scrutiny of these contracts or agreements constitutes one of the important functions of audit, some of which are discussed below:- c. Foreign Technical Collaboration Agreement: This agreement may be a pure technical collaboration agreement or technical-cum-financial collaboration agreement. In the latter, there is equity participation also. Sometimes, collaboration agreements are only financial in nature wherein only equity participation by a foreign company is involved. This is relevant for the following reasons: * Where there is equity participation, imports from the collaborator may be subjected to scrutiny; * Payment of royalty/technical know-how fee may involve GST liability towards import of services including IPR; * Whether consideration paid to the collaborator has been taken into account in arriving at cost of production; etc. * When ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... certificate is obtained has to be reversed. The exact liability of the GST on such projects can be arrived at only after the details of the agreements are * studied thoroughly in consonance with the provisions of the GST Act and Rules. The treatment of transfer of development rights and implications in varied schemes like rehabilitation also have to be understood clearly. f. Works Contract: Works contract is an activity wherein supply of both service and goods takes place, for example, construction of building; erection, commissioning, installation of plant and machinery, etc. In common parlance, a works contract relates to both 'movable property' and 'immovable property'. In the Service Tax regime, the service portion in the supply of works contract service for carrying out construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, alteration of any 'moveable property' or 'immoveable property' was subjected to levy of Service Tax. In the GST period, the definition of works contract has been restricted to any work undertaken for an 'immovable property' only. Consequently, any composite supply (comprising supply of goods and su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case may be. The value of land or undivided share of land, as the case may be, in such supply shall be deemed to be one third of the 'total amount' charged for such supply. g. Manufacturing Agreement: There can be contract / manufacturing agreements which a company might enter into with another company, usually brand owner of repute. Such brand owning companies usually contract out the manufacturing of finished goods to a contract manufacturing facility under certain terms and conditions. This is relevant for the following reasons:- * The payment under the contract manufacturing arrangement may be looked into; * What happens to the waste and scrap generated under the contract; * Whether the contract manufacturer is the real manufacturer or the dummy created for the purpose of declaration of lower assessable value; * Whether the agreement contains any other consideration which can be converted into monetary terms; etc. h. Service Agreement: There may be service agreements/MOUs on various aspects of the business. In some businesses, Purchase Orders constitute the agreement which contains various terms and conditions for supply of services. Specific focus could be sector- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated. These purchase contracts/tenders may also contain information related to audit. This is relevant for the following reasons:- * Who is the supplier; whether he is related person or not; * Whether the delivery of goods made directly to factory or to job worker; etc. l. Lump sum turn-key contract: The assessee may have a turnkey contract which may involve supply, erection at site and commissioning of the goods. This is relevant for the following reasons:- * Whether the price of the goods is inclusive of erection, commissioning at site; * Whether any attempt has been made to overload the erection and commissioning charges; * Whether the machinery is supplied by the manufacturer; etc. * Case study of solar project (70% of value as goods @ 5% and 30% of value as services @ 18%). m. Apart from the above there can be many other types of contracts/agreements such as Works Contracts, Constructions contracts, Leasing contracts, Hire purchase agreements, Franchisee agreements, Non- disclosure agreement, Non-Competitive contract , Insurance and reinsurance agreements / contracts, Banking contracts - to the extent of the Banking fees, charges, penalties charged for services ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity, scalability etc. Effective GST software can aid businesses in managing their finances, accounts, inventory, purchase, sales, payroll, taxation, and other processes efficiently. c) Financial Accounting System is an accounting system where the financial data of the organization is maintained. It is important for auditors to be well conversant with various industry standard softwares like SAP, Oracle, Tally etc.; and also to various accounting methods like Cash Accounting and Accrual Accounting methods. Hence, the auditors must be well trained in financial accounting concepts and use of financial accounting systems that would help them examine and analyze the accounting process, various transactions and ledgers of the assessee while correlating the same with various GST Returns, financial statements etc. Therefore, it is necessary to: * Impart knowledge related to latest financial accounting systems and methods through various training programs; * Use of Software for identifying risk parameters similar to CAAP used in the Central Excise regime. * Developing software to collect back up of Financial Accounts maintained by the Taxpayer. 9.2.10 Audit in an ERP Environment a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt, Multi- Currency Management and Tax Management and therefore, the GST officer auditing an entity should be able to understand various aspects related to these automated accounts. d) The traditional system of bookkeeping mandated the preparation of separate ledgers like the Purchase Ledger, Sales Ledger, Credit Ledger, Bank/Cash Book etc. but the shift to the automated environment has done away with these requirements and all the transactions are now integrated. An enterprise resource planning system inherently means that all the modules within the system are seamlessly connected with each other and the transactions flow through the relevant modules. Thus, there is one Primary Set of Books and all the transactions reside here. For example, if we take 2 purchase transactions involving 2 Vendors Purchases Dr - Purchase Control Account To Vendor 1 A/c - Creditors Control Account Purchases Dr - Purchase Control Account To Vendor 2 A/c - Creditors Control Account e) In the above example, the ERP will maintain the details of transactions separately for Vendor 1 and Vendor 2 and also have a Creditors Control Account to capture the total of all Creditors balances. f) In such a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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