Audit Notes

Tax audit is an examination of your tax return by the IRS to verify that your
income and deductions are accurate. A tax audit is when the IRS decides to
examine your tax return a little more closely and verify that your income and
deductions are accurate.

What is tax audit?

There are various kinds of audit being conducted under different laws such as
company audit/statutory audit conducted under company law provisions, cost
audit, stock audit etc.
Similarly, income tax law also mandates an audit called „Tax Audit‟. As the name
itself suggests, tax audit is an examination or review of accounts of any business or
profession carried out by taxpayers from an income tax viewpoint. It makes the
process of income computation for filing of return of income easier.

Objectives of tax audit

Tax audit is conducted to achieve the following objectives:

 Ensure proper maintenance and correctness of books of accounts and

certification of the same by a tax auditor

 Reporting observations/discrepancies noted by tax auditor after a methodical

examination of the books of account

 To report prescribed information such as tax depreciation, compliance of

various provisions of income tax law etc.
All these enable tax authorities in verifying the correctness of income tax
returns filed by the taxpayer. Calculation and verification of total income,
claim for deductions etc. also becomes easier.

Who is mandatorily subject to tax audit?

A taxpayer is required to have a tax audit carried out if the sales, turnover or gross
receipts of business exceed Rs 1 crore in the financial year. However, a taxpayer
may be required to get their accounts audited in certain other circumstances. We
have categorised the various circumstances in the tables mentioned below:
NOTE: The threshold limit of Rs 1 crore for a tax audit is proposed to be increased
to Rs 5 crore with effect from AY 2021-22 (FY 2020-21) if the taxpayer‟s cash
receipts are limited to 5% of the gross receipts or turnover, and if the taxpayer‟s
cash payments are limited to 5% of the aggregate payments.
What is Fraud?

The main objective of auditing is to ensure the financial reliability of any

organization; detection of fraud is just an incidental object.
Independent opinion and judgement form the objectives of auditing. The job of an
Auditor is to ensure that the books of accounts are kept according to the rules
stipulated in the Companies Act; an Auditor also needs to ensure whether the
books of accounts show a true and fair view of the state of affairs of the company
or not.
The following are the three distinct types of fraud −

 Misappropriation of Cash
 Misappropriation of Goods
 Manipulation of Accounts

Misappropriation of Cash

Misappropriation of cash is the easiest way of fraud especially in large business

houses where there is limited or no communication between the owner of an
organization and the cashier. Following are some of the ways through which
embezzlement or misappropriation can be done −
 Theft of cash receipts and petty cash and showing fictitious payment to
workers, creditors, purchases, etc.
 Showing false payments or excess payments in cash book.
 By using the Teeming and Lading method, the money received from any
customer can be pocketed and the money received from another customer
can be shown as money received from the former.
 Cash sale can be shown as credit sale.
Strict internal control system should be followed in receipts and payments of cash
so that the work done by one person should be automatically checked by another
person.

Misappropriation of Goods

Misappropriation of goods can be done in the following ways −

  Goods may be stolen by employees or with the help of employees.
 By issuing false credit notes to customer on account of goods return.
Detection of misappropriation of goods is more difficult rather than detecting
misappropriation of money, especially where management is not much vigilant
and sound system of book-keeping, internal control and adequate system of
securities are not available. To keep control on the physical verification of goods,
reconciliation of physical stock with books and careful checking of sale and
purchase is must.

Manipulation of Accounts

Two types of manipulation of accounts are mainly done by top management to

mislead some parties for some specific purpose.
 Showing higher profits − Following are the reasons behind showing higher
profit than actual −
o To obtain credit or to enhance existing credit from financial
institutions and also to show credit worthies to suppliers of the
company.
o To maintain confidence of shareholders.
o To hike the market price of shares of the company and enable the sale
of those at higher price, it may be done by declaring higher dividends
on shares.
o To get more commission where commission is calculated on the basis
of profit earned.
o To declare dividend at higher rate.
 Showing low profits − Following are the reasons behind showing lower
profit than actual −
o To avoid or to reduce Direct Taxes of the company (Income Tax,
Wealth Tax).
o To purchase shares at lower price.
o To give wrong impression to the other competitors of the business.

Manner of Manipulation of Accounts

Manipulation of accounts may be done in the following ways −

  Window dressing is a manipulation or miss-representation of financial data
in such a way that it seems better than what it actually is. Some of the
method of window dressing is given as hereunder.
o Over valuation of closing stock
o Under valuation of Liabilities or Over-valuation of assets
o Purchases and expenses of current year may be deferred to next
financial year
o Charging revenue expenses as capital expenditure
o Sale and other incomes of preceding year may be shown as income or
sale of the current year.
 Secret reserves of previous years may be used in the current financial year
to inflate the profit or secret reserves may be created to suppress the profit
of the current financial year.
 Stock may be under or overvalued. Income and sales may be suppressed or
inflated. Expenses and purchases may be suppressed or inflated.

Difference Between Vouching and Verification

Vouching is the soul of Auditing because it forms a base for an effective audit
procedure. Vouching means “to vouch” i.e. examine the vouchers. On the other
hand, Verification means “to verify” the assets and liabilities of the business. Both
the two terms are the first two steps of Auditing, infact vouching helps in the
process of verification.

In firner terms, Vouching implies the act of checking the vouchers, to identify the
authenticity of the transactions recorded. Conversely, Verification alludes to a
process, adopted by the auditor to examine the assets and liabilities.

To a layman, these two processes are one and the same thing, but they are
different. So, here is an article presented to you which attempts to shed light on the
differences between Vouching and Verification, which we have compiled after a
thorough study on the two.