INTRODUCTION
A statutory audit is conducted to elicit an
opinion as to whether the financial statements of an enterprise provide a true
and fair view in conformity with the generally accepted accounting principles /
laid down guidelines. The effect on the financial statements of various laws
and regulations varies considerably. SA 250, Consideration of Laws & Regulations
in an audit of Financial Statements, provides guidance to the auditors on
how to identify material misstatement of financial statements due to
non-compliance of other laws. It also clarifies that the auditor cannot be
expected to detect non-compliance with all laws and regulations.
GST, as a transactional indirect tax law,
can have significant impact on the financial statements of an entity and
therefore appropriate compliance with the GST law is one of the important
validations that a statutory auditor has to perform before he can conclude
about the true and fair view of the financial statements. At the same time,
being a recent law with multiple interpretations and conflicting clarifications
and advance rulings, at times it can be an impossible journey for the statutory
auditor to come to an assertive judgement on the extent of compliance or
non-compliance.
This article highlights some examples
whereby the interplay between the statutory audit process and the GST domain
can be better appreciated.
DIFFERING
OBJECTIVES & FOCUS
As stated earlier, the objective of
statutory audit is to validate that the financial statements present a true and
fair view of the financial affairs of an enterprise. To that extent, the core
focus of a statutory audit (and financial accounting) is on the enterprise or
the entity. The financial statements are prepared on the basis of various
accounting policies, the disclosure whereof is governed by the provisions of
Accounting Standard 1 (AS1).
However, when it comes to GST, this is a
transaction-driven tax law and therefore the core focus changes to individual
transactions, whether such transactions constitute supply, whether the levy
provisions are attracted and whether there is a tax prescribed for the same.
GOING CONCERN
One of the fundamental accounting
assumptions is ‘going concern’. As per AS1, the enterprise is normally viewed
as a going concern, that is, as continuing in operation for the foreseeable
future. It is assumed that the enterprise has neither the intention nor the
need of liquidation or of curtailing materially the scale of its operations.
The GST law does not explicitly state such
an assumption; however, the same is inherent in the overall scheme except to
the extent that a person obtains a registration as a casual taxpayer – which
indicates the intention of the taxpayer to do business only for a limited time
frame. Can the absence of a normal registration and only casual taxpayer
registration prompt the statutory auditor to question this fundamental accounting
assumption as a going concern? It may be relevant to bear in mind that GST is a
state-level registration whereas the financial statements pertain to the entire
world.
In actual experience, entities end up with
substantial accumulation of input tax credit (ITC) under some GST
registrations. Considering another principle of conservatism, at times,
statutory auditors question the possibility of realisation of the accumulated
ITC balance and insist on writing it off on the grounds of non-recoverability
or reversal of such credits. Since the credit once legally availed is
indefeasible, without any time limit under the law and there being a fair
chance that it could be availed in future, whether it is correct on the part of
the statutory auditor to insist on writing off the accumulated ITC balance
simply due to the age of such asset while continuing to maintain that the
assumption of going concern is valid?
CONSISTENCY
AS1 further states that it is assumed that
accounting policies are consistent from one period to another. However, when it
comes to GST, it being a transaction-driven tax, each transaction can have
different tax implications based on the ‘form’ of the said transaction. As
explained a little later, GST concentrates on the ‘form’ of the transaction
rather than the ‘substance’. Further, the GST law at various places provides
flexibility of interpretation or positions taken by the taxpayer. For example,
Entry 2 of Schedule I is often understood to require the head office of a multi-locational
enterprise to raise a notional cross-charge invoice on its branches located in
other states. The proviso to Rule 28 permits the head office to choose
the valuation mechanism for such cross-charge as per its convenience and
prohibits the GST officers from questioning such a valuation mechanism. In the
backdrop of the said legal provisions, is it permissible for the head office to
choose different valuation principles for cross-charge to different branches?
Can the statutory auditor object to such a position on the grounds of violation
of the fundamental accounting assumption of consistency? In the view of the
authors, the notional cross-charge does not represent an accounting policy and
hence the principle of consistency may not be relevant in such a scenario.
ACCRUAL
AS1 further states that revenues and costs
are accrued, that is, recognised as they are earned or incurred (and not as
money is received or paid) and recorded in the financial statements of the
periods to which they relate. However, the liability towards GST is triggered
when the provisions of time of supply are attracted. In general, the time of
supply provisions get triggered at the earliest point of invoicing, completion
of service / removal of goods or the receipt of advance and therefore the
accounting concept of accrual has no relevance to the GST liability. However,
in case of import of services from an associated enterprise, the time of supply
(and consequential GST liability under reverse charge mechanism) is triggered at
the time of booking the provision in the books of accounts itself. This
presents a substantial challenge in case of multinational corporations where
the royalty payable to the foreign parent itself is determined based on the
finalisation of the revenue for the particular year. In view of the requirement
to provide for such royalties in the books of accounts at the year-end even
though the quantum of royalties itself is determined after the year-end, such
organisations end up in delay in the discharge of GST. Whether such
discharge of statutory dues due to reasons beyond the control of the taxpayer
would merit reporting under the provisions of CARO?
In view of the time of supply provisions
under GST, many notional entries / adjustments which find a way in the
accounting and statutory audit space have very limited relevance in the context
of GST. Having said that, at the adjudication level the assessing officers tend
to look at the financial statements as the starting point for obtaining prima
facie comfort on the completeness of the GST compliances. This typically
results in the preparation of a reconciliation statement which attempts to
bridge the gaps between the turnover as reported in the financial statements
and the aggregate turnovers reported in multiple GST registrations obtained by
the enterprise.
While it may be correct as well as prudent
to undertake the reconciliation referred to above, at times the inability to
appreciate the exact interpretation and ramification of each reconciliation
adjustment results in wrong demands being raised which have to be agitated
before the judicial forums.
Interestingly, many notional entries /
adjustments are insisted upon by the statutory auditors at a global level at
the time of finalisation of statutory audit. In the case of multi-locational
enterprises, it may become challenging for the taxpayer to allocate the values
of such notional entries / adjustments to the respective GST registrations. In
such cases, whether it would be appropriate for the GST officers or the
statutory auditors to once again insist on the state-level split of such
notional entries / adjustments, or could the same be ignored as being
inconsequential in the GST process?
PRUDENCE
AS1 further recognises that an enterprise
may select accounting policies suitable to the disclosure of the over-arching
objective of presentation of a true and fair view of the financial statements
of an enterprise. While selecting accounting policies, AS1 specifies prudence
as an important consideration for the selection of an accounting policy. As
stated in AS1, in view of the uncertainty attached to future events, profits
are not anticipated but recognised only when realised, though not necessarily
in cash. Provision is made for all known liabilities and losses even though the
amount cannot be determined with certainty and represents only a best estimate
in the light of the available information.
A common example of the prudence principle
at play is that of valuation of inventories at cost or market value, whichever
is lower. However, when it comes to GST, Rule 28(a) prescribes that inventory
movements across multiple GST registrations of the same legal entity should be
carried out at market value. While the proviso to Rule 28 grants
flexibility to the taxpayer in many cases, if the recipient branch is not
eligible for full ITC, the said Rule is in stark contrast to the time-tested
accounting principle of prudence. Is the ERP of the enterprise geared up to
duly comply with the GST law (by valuing such branch transfers above cost) as
well as the accounting principles (by once again creating a provision for such
notionally inflated value of inventory)? Assuming that the enterprise has
valued such inventory movements at cost and the same is objected to neither by
the GST officers nor by the GST auditors, can the statutory auditor qualify his
report to observe this non-compliance, especially considering that accounting
wisdom would suggest exactly what the taxpayer has done?
Even in normal scenarios where slow-moving
inventory is valued below cost, the issue which needs to be examined is whether
such valuation below cost would trigger the provisions of section 17(5)(h)
which requires the reversal of ITC if the goods on which ITC is claimed are
written off. A possible view could be taken that there is a difference between
‘write-off’ of goods and reduction in the value of the goods on account of an
accounting policy.
Similarly,
when the statutory auditor insists that a refund shown as receivable in the
balance sheet be written off as being unlikely of recovery due to some dispute
with the Department, it can prejudice the claim of refund since the judiciary
may interpret non-appearance of the asset in the balance sheet as a case of
unjust enrichment. This is one more area of interplay where the statutory
auditor will need to exercise caution rather than pre-judge the situation.
SUBSTANCE
OVER FORM
Another consideration in the selection of an
appropriate accounting policy is the choice of substance over the form of a
transaction. It is such consideration which requires that leases be accounted
in a particular manner. In stark contrast to the accounting / auditing
preference of substance over form, the tax laws typically concentrate on the
form rather than the substance. However, the classification of goods as inputs
or capital goods depends upon the accounting treatment.
An interesting issue arose in the case of an
airport operator working on the BOT model. Ind-AS 115 required that the
construction cost be treated as revenue expenditure and then be taken to the
Balance Sheet as an intangible asset to be amortised over the life of the
concession. Section 17(5)(d) does not permit the ITC of construction cost if
the same is incurred for own account and is capitalised in the books of
accounts. The airport operator relied on a series of Supreme Court judgments
under the earlier excise / service tax / income tax laws and also a High Court
judgment under the GST law to claim the ITC. However, the statutory auditor was
of the view that the ITC is not available. The airport operator backed up his
position with an opinion from a Senior Counsel from the Supreme Court. However,
the statutory auditor was not convinced. Perhaps, the auditor skipped three
important aspects while framing his view:
(1) SA 500 – Audit Evidence, which
deals with this issue, provides that the auditor should determine if the
evidence tendered by the auditee is sufficiently appropriate. This can be done
by:
- Evaluating the competence, capabilities
and objectivity of that expert,
- Obtaining an understanding of the work of
that expert,
- Evaluating the appropriateness of the
expert’s work as audit evidence for the relevant assertion.
(2) The difference between the concepts of
amortisation of an intangible asset and depreciation on tangible assets.
(3) By implementing Ind-AS 115, a position
is taken in accounting that the construction is not on account of the airport
operator but is on account of the Government. Having taken that position and
implemented the same, whether the statutory auditor can bounce back to the form
of the transaction and disregard the conduct in accounting?
MATERIALITY
The selection of accounting policy is also
based on the consideration of materiality. In fact, the entire accounting and
auditing process considers materiality and significance as an important
benchmark for any action or inaction. As compared to accounting and auditing,
admittedly, GST law does not define any concept of materiality, much less an
objective benchmark of what constitutes material items. Having said that, one
may need to bear in mind that GST law is nascent and there are many
interpretation issues and conflicting advance rulings. In such a scenario,
to what extent should the statutory auditor step into the shoes of the
assessing officer and define non-compliance of the GST laws? Is it the
prerogative of the statutory auditor to arrive at authoritative conclusions on
debatable legal issues and consequentially qualify financial results on the basis
of apprehensions of likely Department action? How would one define materiality
in this regard?
The classification of a transaction as
intra-state or interstate supply and the consequential levy of CGST+SGST or
IGST is based on the correct legal identification of the place of supply.
Sections 10 to 13 of the IGST Act provide for guiding principles to determine
such place of supply. However, there could be scope of interpretation in some
cases. The taxpayer could have discharged IGST, which in the opinion of the
statutory auditor would merit CGST+SGST, or vice versa. What would be
the role of the statutory auditor in such cases?
The Legislature itself has predicted that
there could be such interpretation issues and therefore has provided through
section 77 of the CGST Act and section 19 of the IGST Act that in such cases
the wrong tax should be refunded to the taxpayer and the correct tax should be
collected. It is further provided that no interest should be charged in such
cases. Since the tax has been fully paid (though under a wrong head of
classification), many judicial precedents suggest that there should be no
penalty in such cases. In the backdrop of the above provisions, is there a
possibility of a material impact on the financial statements to warrant an
intervention by the statutory auditor?
ROLE OF
THE STATUTORY AUDITOR VIS-À-VIS GST COMPLIANCES
The above discussion on the differing
objectives of the GST law and the statutory audit process based on the
discussion of merely AS1 brings to fore the likely interplay between the two
domains. It is important for the statutory auditor to clearly recognise the
differences and the points of interplay while taking any position on GST. At
the same time, in view of SA 250 and the fact that non-compliances in GST law
could have not only a material impact on financial statements but may also
impact the fundamental assumption of going concern, the statutory auditor may
not be in a position to take the management representations at face value. How
does the statutory auditor strike that delicate balance?
One important aspect which needs to be noted
before moving on is the basic understanding regarding audit, and that is, ‘An
auditor is a watch-dog and not a bloodhound’, meaning the auditor is bound
to give a reasonable assurance on the subject matter being audited and not an
absolute assurance. Based on the various activities undertaken during the
audit, the auditor arrives at a reasonable assurance relating to whether or not
the financial statements give a true and fair view and whether or not there is
any material misstatement? An auditor can express his opinion, which can either
be unqualified, qualified, adverse or a disclaimer of opinion, i.e., abstain
from giving an opinion.
Paragraph 13 of SA 250 requires the auditor
to perform audit procedures which help him to validate compliance with other
laws and also help him to identify instances of non-compliance with other laws
and regulations that may have a material effect on the financial statements.
One of the processes laid down in the SA is to obtain representation (SA 580)
from management as to whether the entity is complaint with such laws and
regulations.
However, mere representation from the
management is not sufficient. The auditor cannot blindly rely on the
representation. He should understand the process designed by the company to
comply with GST compliances and various checks and controls employed by the
company and how the process is actually implemented in reality. This should
include a review of multiple aspects which can be broadly classified as:
(1) Operational Review through a walkthrough
of sample transactions,
(2) Transactional Review of identified
sample transactions,
(3) Final Review of financial statements and
the assertions made through such statements.
OPERATIONAL
REVIEW THROUGH A WALKTHROUGH OF SAMPLE TRANSACTIONS
1. Understanding of business
As part of the general audit procedure, the
statutory auditor is expected to have reasonable knowledge about the business
of the enterprise. When it comes to GST, a slightly more detailed knowledge of
the business (more specifically the products and the services offered by the
enterprise) may be required. The tax rates, exemptions, reverse charge
applicability, etc. to a substantial extent depend on appropriate
classification of the goods and the services.
It may be useful for the statutory auditor
to obtain the list of HSN classifications of the products or services and the
tax rates applied on them. On a random basis, it may also be appropriate to
review the process of creation of masters in the ERP / Invoicing Software to
ensure that the positions taken by the enterprises are reflected in the conduct
of the enterprise. Depending on the time at the disposal of the auditor and the
materiality, the auditor may also like to examine independently the correctness
of the HSN classifications and the tax rates based on the notifications,
circulars and the advance rulings available in the public domain. However, in
cases where there are conflicting views, it could be perfectly in order for the
statutory auditor to rely on an expert opinion obtained by the auditee in this
regard. In case there is no active litigation on this issue and generally the
industry also accepts the tax rate adopted by the enterprise, the statutory
auditor could be said to have reasonably performed his duty. The dividing line
between the role of a statutory auditor and an investigating tax officer is
very well understood in theory but fairly blurred in practice and the auditor
should use his value judgement in ensuring that he does not transgress this
line.
In case of services, it may also be
important to understand the basis on which the enterprise defines the ‘location
of the supplier’. This may be especially important in multi-locational entities
like banks and insurance companies. It may not be feasible for the auditor to
actually examine each transaction to ensure full compliance. Besides, the law
in this regard is fairly ambiguous. Therefore, a general understanding of the
process may be obtained and validated with a few sample transactions. At this
point, the interplay of contractual obligations vis-à-vis the service
performance locations may have to be examined closely and accordingly the
principles of cross-charge of services instituted by the enterprise may be
revalidated.
2. Understanding the Procurement to
Pay (P2P) Cycle
In view of the requirement for matching of
vendor credits, correct implementation of the P2P Cycle and appropriate vendor
due diligence are very critical. It may be useful for the statutory auditor to
review the processes of vendor master creation and validation of the GST
registration obtained by the vendor. On a regular basis, the GRN closure
process could be reviewed to verify that the ITC claim is not unnecessarily
delayed. The auto-populated credit statement in Form GSTR2A available on the
GST Portal can be an important audit tool to verify cases of delayed booking of
invoices in the system. At the same time, it may be useful for the statutory
auditor to bear in mind that GSTR2A is a document not in the control of the
auditee and therefore if third parties have made errors in uploading
information in GSTR2A, the taxpayer cannot be faulted for such erroneous
entries. Similarly, in view of the suspension of the Government-controlled
matching process proposed at the time of the inception of GST, non-reflection
of ITC in GSTR2A may not imply non-compliance on the part of the assessee and
could not result in denial of ITC if the said non-reflection is within the
tolerance limits specified under Rule 36(4).
While reviewing the P2P Process, it may also
be important to examine the extent of automation in relation to the processes
of identification of non-eligible credits and the applicability of RCM. At this
point, it may be important to examine the process and system instituted for the
said identification rather than cherry-pick individual transactions and
question the positions already taken by the assessee and duly supported by
adequate prima facie reasoning or expert opinions.
While on the P2P Process, it may also be appropriate
to have a review of the inventory cycle to examine situations of shortage, free
supplies, write-offs, destructions, etc., and to revalidate that appropriate
ITC has been reversed in such scenarios. The auditor may bear in mind a
possible legal interpretation that the provisions of section 17(5)(h) get
triggered only in case of inventory items which are procured from outside and
not for finished stocks.
In certain cases, liquidated damages,
discounts, incentives, etc., are recovered from the vendors. Such recoveries
may appear in the financial statements as ‘other income’ and, therefore, it is
natural for a statutory auditor to inquire about the applicability of GST on
such ‘other incomes’. However, in case the taxpayer wishes to rely on the decision
of the Mumbai High Court in the case of Bai Mamubai vs. Suchitra
and contend that there is no underlying supply by the taxpayer to the vendor,
in the view of the authors it would be sufficient for the statutory auditors to
take such management representation on record rather than impose their
interpretation on the taxpayer.
3. Understanding the Ordering to Cash
(O2C) Cycle
In many organisations, the O2C Cycle may not
comprise of merely one ERP / IT system but may be an integration of multiple
invoicing, delivery and performance modules. In such a scenario, it may be
important for a statutory auditor to understand the specific delivery modules
and their linkage with the invoicing modules which in turn flow the information
into the financial system. It may also be important for the statutory auditor
to have knowledge about the specific system which generates GST-compliant tax
invoices. On a random basis, the review of a few tax invoices to ensure
appropriate GST compliance may be in order. In view of the speedy and
unorganised phase-wise customisation of GST in many organisations and the
limited support offered by ERP software, this integration of the revenue and
the tax GLs becomes very critical in ensuring correct GST compliance. This
aspect becomes even more important in complex service establishments like banks
or airlines where revenue is generated from multiple sources and may not be
immediately accompanied by a system-generated invoice.
It may be especially important for the
statutory auditor to verify the checks and controls within the organisation to
ensure that manual or draft invoices are not issued from outside the system. In
many cases, such manual / draft invoices are later regularised in the ERP but
this results in substantial reconciliation issues since the enterprise
would upload the ERP invoice whereas the customer will upload the manual /
draft invoice.
4. Understanding the Financial and
Cost Control (FICO) Modules
The Financial System (FI) Module would take
care of most of the residuary activities within the organisation and therefore
becomes a crucial module for review. Depending upon the extent of automation
and control, it is quite likely that specific tax GLs would be locked for
manual entries. However, if such controls do not exist it may be appropriate
for the auditor to scrutinise the tax GLs in detail to identify such manual
entries and make sure that such manual entries are correctly recorded. A
reconciliation of the tax GLs with the electronic ledgers maintained on the GST
Portal may also provide some indications of non-compliance.
5. Understanding Generic GST
Compliances
Having obtained an overall understanding of
the business processes and systems controls, it may then be relevant for the
statutory auditor to venture into a review of the GST processes undertaken by
the enterprise. Some indicative steps could be as under:
(a) Whether proper registration has been
obtained by the company?
Having understood the nature of business of
the enterprise, it may be useful for the auditor to cross-check whether it has
obtained all the required registrations. Section 22 of the GST Act requires
every assessee to obtain a registration in each of the states from where it
makes a taxable supply. In view of the provisions of Entry 2 of Schedule I, certain
branch transfers are deemed to be taxable supplies. Considering the interplay
of these two provisions, the auditor may like to examine whether or not all
branches are registered under GST. If they are not registered, the reason for
such non-registration may also be examined.
How does one determine whether any place
requires a registration or not? Can there be an imputation of place of business
in cases where employees work from home or from client locations? Since the
concept of ‘fixed establishment’ under the GST law requires a physical place of
permanence with sufficient technical resources to render a service, it may be
in order for the statutory auditor to restrict his inquiries only to the
branches which are physically owned / leased by the enterprise rather than
impute the possibility of a place of business and insist on additional
registrations.
(b) Whether taxes are being properly
discharged?
This is an important part from the GST
perspective. GST, as stated above, is a transaction-based tax, i.e., it applies
on almost all transactions undertaken by a company. Therefore, automation in
the process becomes important. This automation can be from different
perspectives such as:
- Booking of all incomes and expenses at
correct locations resulting in booking of GST liabilities and credits also at
the correct locations,
- Booking GST amounts in books.
(1) Is booking of invoices automated or tax
amounts are manually entered in systems? Especially in the context of sales
invoicing where companies issue invoices in a different environment which is
then sourced into the accounting system?
(2) How are various factors determined, such
as HSN, rate of tax, place of supply, etc.? What is the level of manual
intervention involved and determining the scope of errors?
(3) Are reports for GSTR1 auto-generated or
there is a need for manual intervention?
(4) What is the basis to determine
eligibility of ITC and when is it done?
(5) What is the basis to determine liability
to pay tax under reverse charge?
(6) What method is applied for complying
with provisions of Rule 36(4) – matching of credits?
(7) Whether proper accounting entries are
passed in the books of accounts relating to liabilities and credits?
(8) Whether tax payable on outward supplies
is computed correctly compared with the corresponding GST Rate? Whether the
amounts match with the tax collection as per liability GLs?
(9) Whether tax liability is triggered on
all inward supplies liable to reverse charge and at the correct rate? Whether
monthly reconciliation with expenses booked in corresponding GLs is prepared?
(10) Whether the balance as per the books of
accounts is reconciled with the corresponding balance on the GST Portal? In
case there are differences, are the same reconciled?
(c) Whether there are any disputed
statutory dues? If yes, the forum before which the dispute is pending and the
amounts involved in the dispute?
This would cover disputed dues other than
the above and would also include dues which have been demanded by the tax
authorities but not accounted for in the books of the company. For example, the
company has treated a particular transaction as not liable to tax for reasons
such as exports, exempted, etc., or a claim of ITC is disputed by the tax
authorities. Such instances would not be reported as liability in the books of
accounts and therefore the auditor would be required to undertake specific
steps to identify such instances.
Under GST, there is a facility to maintain
all assessment proceedings, such as issuance of notices, orders, etc., online
on the GST Portal. Therefore, one way to identify disputes under GST is by
checking the details of notices issued to a company in the notice section of
each GSTIN. In case notice has been issued, identifying the status of the
said notice as to whether the same is relating to a recovery proceeding or
procedural aspect. Generally, a mere notice for recovery should not require
reporting under CARO. However, if the notice has been adjudicated and an order
issued with respect to the same against which the company has filed an appeal,
the same would require reporting under this tab.
However, all field formations do not follow
this automated process and there are instances when the notices, orders, etc.,
are issued manually. In such cases it would be difficult to ascertain the new
disputed dues and therefore for the same he can check the litigation tracker,
if any, maintained by the company and do the above exercise, or rely on the
management representation to this extent.
CONCLUSION
As stated earlier, a statutory auditor may
need to adopt a three-pronged approach towards ensuring adequate GST
compliance. While doing so, he should attempt to achieve reasonable assurance
that there is no significant misstatement of the financial results on account
of GST. This is a subjective analysis and no defined monetary benchmarks can be
established except by analysing the probable consequences. However, what may be
important is to prioritise the aspects of systems and processes and controls
and validate the business processes through review of sample transactions
rather than step into the shoes of an assessing officer and question the
interpretations adopted by the enterprise.
We have discussed in this article the
conceptual framework and aspects relating to the operational review. In the
next article, we shall cover in detail some aspects related to transactional
review and the final review of the financial statements, including assertions
made therein.
[This article has received
substantial inputs from Editor Raman Jokhakar whose contribution the
authors would like to acknowledge.]
