Analysis of Revised Form No. 3CD: Clause 40 – Accounting Ratios & Business Parameters

Introduction:

Clause 40 of the tax audit report requires the disclosure of important financial information regarding turnover, gross profit, net profit, stock-in-trade, and material consumption/finished goods production for the previous year and the preceding previous year. These details are crucial for stakeholders to assess the performance and capability of the business being audited. This clause applies to assesses engaged in manufacturing or trading activities, including the trading of goods or services. However, it does not apply to professional service providers who are not engaged in trading services. In this section, we will explore the applicability, analysis, and reporting requirements of Clause 40.

Clause 40 : Details regarding turnover, gross profit, etc. for the previous year and preceding previous year:

(The details required to be furnished for principal items of goods traded or manufactured or services rendered)

Background

Clause 40 requires reporting of the performance or capability of the business of the assessee in the form of Ratios/Parameters. This clause enables stakeholders to judge the performance of the business of the assessee by providing details for the preceding previous year.

Applicability

As per para 67.1 of the Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 (Revised 2014 Edition), in short ‘Revised Guidance Note’ issued by the Institute of the Chartered Accountant of India (ICAI), the reporting of the ratios referred to in Clause 40 is applicable only to assesses engaged in Manufacturing/Trading activities. It may be noted that trading activities may involve trading of goods or services. Thus, it can be inferred that if the assessee is engaged in the trading of services, then reporting under this clause would be applicable. However, this clause is not applicable to professional service providers as they are not engaged in trading of services. However, information about ‘turnover’ may be given based on ‘gross receipts’.

Analysis of Clause 40  of Revised Form No. 3CD 

• According to the clause, the information regarding turnover and ratios should be furnished for the principal items of goods traded or manufactured or services rendered by the assessee during the previous year. Furthermore, the information should also be given for the preceding previous year for ease of comparability.
• Since it may not be practicable to give the ratios based on the principal items in most cases, the ratios may be calculated for the business as a whole. Additionally, while providing information about the preceding previous year, the information as given in the tax audit report for that year should be reported (kindly refer to para 67.9 of the Revised Guidance Note).
• In case no audit has been conducted for the preceding previous year, a disclaimer/observation/qualification may be given stating the true and correct fact in the Tax Audit report in Form 3CA/CB, as the case may be. If the Tax Audit for the preceding previous year has been conducted by another auditor, then the ratios calculated by such an auditor can be relied upon. The Tax Auditor may refer to the information in the Tax Audit report.

Sr. No. 1: Total Turnover of the Assessee

• Under serial number 1, the figures for turnover of the Assessee are to be given. Unlike calculation of ratios listed under 2 to 5, information regarding turnover based on principal products/services may be possible to extract. The turnover figures may be given for principal products/services to the extent possible. Wherever it is not practicable to give such classification, the information may be given for the business as a whole. It is advisable that the Tax Auditor while giving information under this clause should make suitable disclosures as regards basis for calculation of turnover and the ratios. Further, the information about the turnover needs to be given only in respect of business which is subject to the tax audit.
• The Turnover is defined in the Revised Guidance Note as

“The aggregate amount for which sales are effected or services rendered by an enterprise. The terms gross turnover and net turnover (or gross sales and net sales) are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts.

• For the definition and the calculation of the Turnover/Gross Receipts, refer Para 5 (Sales, Turnover, Gross receipts) of the Revised Guidance Note).

Sr. No. 2: Gross Profit/turnover (Gross Profit to Turnover ratio)

• The Gross Profit is defined in the Revised Guidance Note as “The excess of the proceeds of goods sold and services rendered during a period over their cost, before taking into account administration, selling, distribution and financing expenses. When the result of this computation is negative it is referred to as gross loss.”
• In case of trading in variety or different types of goods each having different margins, it is not necessary to give the Gross Profit Ratio product-wise. It is sufficient to give overall Gross Profit Ratio for the business.

Sr. No. 3: Net Profit/turnover (Net Profit to Turnover ratio)

• The Revised Guidance Note defines the Net Profit as “The excess of revenue over expenses during a particular accounting period. When the result of this computation is negative, it is referred to as net loss.”
• Extra-ordinary items are normally excluded from net profit for the purpose of calculating Net Profit Ratio unless such items materially affect the situation. In such case, suitable note/disclosures may be made in the report.
• The net profit to be shown in this clause is Net Profit Before Tax.
• In case of partnership firm, the author is of the view that the Net Profit should be calculated after charging interest and remuneration to the partners. Though the interest on capital employed and the remuneration is merely an allocation or distribution of the profit to the partners, however, it is allowed as an expense/deduction as per the provisions of the I.T. Act, 1961 subject to certain limits and conditions. In an alternate view, the Net Profit may also be calculated before charging interest and remuneration to the partners.

Sr. No. 4: Stock-in-trade/turnover (Stock-in-Trade to Turnover ratio)

• For calculating ratio under serial number 4, only the closing stock is to be considered. The term ‘stock-in-trade’ includes only finished goods and does not include the stock of raw material and work-in-progress, since the objective is to compute the stock-turnover ratio (refer para 67.4 of the Revised Guidance Note). Further, the term ‘Stock-in-trade’ used therein does not include stores and spare parts or loose tools. For calculating Stock Turnover Ratio, closing stock should be considered and not average stock.
• Reporting requirement in this point arises only in respect of manufacturing/trading activities of the Assessee. In case the Stock-in-trade at the end of the year is NIL, then ratio list under serial number 4 would not be applicable.

Sr. No. 5: Material consumed/finished goods produced

• Material consumed, apart from raw material consumed, also includes stores, spare parts and loose tools (refer para 67.5 of the Revised Guidance Note).
• The ratio mentioned in serial number 5 is not applicable to Trading or service activities. If the assessee acts as a job worker, then ratio in serial number (5) need not be given. The ratio under serial number 5 is to be given in value and not in terms of quantity. The results of the ratios are to be given in percentage terms as per the utility.

Other considerations with regard to calculation of ratios

• The value of finished goods produced may be arrived at by using the following formula:

• Consistency: While reporting different ratios, consistency between the numerator and the denominator should be maintained. Any significant deviation thereof should be pointed out in the Tax Audit Report.
• Composite activity: In case the Assessee is carrying on composite activity (i.e., trading as well as manufacturing), then ratios may be given for a business as a whole and there is no need to split the activities to calculate these ratios.
• Reporting of workings: It is desirable that the Tax Auditor should also give relevant calculations, computation of various components based upon which these ratios have been worked out. In case, if any of the above component is stated in the financial statements themselves, a reference to the same may be made, to the extent possible. The working of such calculations should be maintained as a part of audit working papers. The same can be incorporated in the hard copy of the Tax audit report submitted to the assessee. Further, the Ratios list under serial numbers 2 to 5 are to be given in (%) terms.
• The Ratios to be given under clause 40 should be based on figures as per the books of account maintained by the assessee and adjustments in respect of sec 145A of the I.T. Act, 1961 are not required to be made for the purpose of calculating the ratios.

Conclusion: Clause 40 plays a significant role in providing stakeholders with valuable insights into the financial performance of businesses subject to tax audit. By disclosing information on turnover, gross profit, net profit, stock-in-trade, and material consumption/finished goods production for the previous year and the preceding previous year, this clause enables comparative analysis and evaluation of business performance. It is essential for tax auditors to ensure accurate reporting, maintain consistency between numerator and denominator, and provide relevant calculations and workings to support the ratios disclosed. Adhering to the guidelines and requirements outlined in the Revised Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 is crucial to ensure compliance and provide reliable information to stakeholders.

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Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.