WHAT IS EXCISE AUDIT 2000 - CBEC Manual (OLD) - Central Excise

CHAPTER 15 WHAT IS EXCISE AUDIT 2000 The new system of audit called the Excise Audit 2000 [EA 2000] was first started in December 1999 on an experimental basis in case of assessees paying duty in PLA over Rs. 5 crore per annum. In September 2000, this system of audit was made applicable to those assessees paying PLA duty over Rs. 1 crore per annum. It was decided to continue with both the systems for time being [prevailing system of audit for the smaller assesses] till EA 2000 audits stabilised and gained acceptability both within the department and among the assessees. With effect from 01-01-2002, the Central Board of Excise and Customs instructed that henceforth all audits would be conducted under EA 2000 system and the traditional system of audit was phased out. EA 2000 audit is based on verification of the private records of the assessee and their methods of accounting record keeping. Starting with the selection of units on the basis of their risk perception, this methodology relies on the efficient use of audit resources viz. manpower and skills. Pre-audit review and the study of system of Internal Control are the main features of this audit. It also lays emphasis on gathering data about the assessee, understanding his financial and accounting system, studying the flow of material, cash and documentation and run tests to evaluate the vulnerable areas. Armed with this information, the auditors prepare an Audit Plan and conduct verification according to that plan. The system requires documenting each step of audit scrutiny and invites the assessee to give his views on all the objections. The ethos of EA 2000 audit is to resolve the tax non-compliance issues by way of constant consultation with the assessee. It aims at settling the audit disputes by way of consensus as far as possible. It involves discussions between senior officers from the department and senior officials of the assessee in the atmosphere of mutual understanding. The stress is therefore on correcting the factors, leading to non-compliance. The broad principles are: [i] Audit will be conducted in a systematic and comprehensive manner. [ii] Emphasis will be on scrutiny of records maintained in the normal course of business. [iii] Audit effort will be based on materiality principle - higher the potential risk, greater the intensity of scrutiny. [iv] Recording of all findings. [v] Audit is clearly distinct from anti-evasion activity - audit can uncover non-compliance only to the extent of their reflection in the books of accounts. Procedure of Excise Audit 2000 The steps in brief are mentioned below. It is important that the auditor records all of the steps, in Working Papers, as he goes along. 1. Selection of Assessee The process of EA 2000 begins with identification of a unit to be audited. Normally, there are about 1000 to 1500 assessees under the jurisdiction of a Central Excise Commissionerate. It is not possible for the audit staff to conduct audit of all the units every year. Therefore, depending upon the manpower availability and the frequency prescribed, units are selected for conducting audit during the financial year. Under the conventional system of audit the units were picked up randomly without any scientific basis of selection. Under EA 2000, the selection of units [other than mandatory units] is based taking into account the 'risk-f actors'. This means that the assessees who have a higher risk-perception are picked up for audit on priority over those whose risk-perception [as reflected by the risk parameters in use] is lower. 2. Preliminary or Desk Review. Upon assignment of an audit, the auditor is required to be sufficiently prepared before the visit to the unit. This is done in the office and involves reviewing all the information available about the unit, its operations, reasons for selection for audit and possible issues that can be identified at this stage. Perusal of Assessee Profile, Annual Report, Trial Balance, Cost Audit Report and Income Tax Audit Report helps the auditor in the preliminary review. The foremost duty of the auditor is to access the Assessee Profile (maintained for the purpose] and other information from the computer wherever computerized information is available. If the information is incomplete, the same should be entered so that in due course information becomes complete. 3. Gathering Information about the Assessee and the Systems followed by him. Before conducting the audit, the auditor gathers information about various activities of the unit like tax accounting, procurement of raw materials, production, marketing, stocks and sales. This information is gathered through discussions with the senior management. In the case of bigger units paying annual PLA revenue of over Rs. 1 crore, this may be done during a brief preparatory visit to the unit and in other cases at the beginning of the single visit for audit-verification. A sample reconciliation of the tax returns with the financial accounts is done. This information collected is documented so as to test it against the actual functions during 'walk through' conducted while evaluating the internal control. 4. Evaluation of the Internal Controls. Internal Controls form a basis for reliability of the company's own accounting records. The evaluation of Internal Controls is necessary for determination of the scope and extent of audit checks required for the assessee. If the internal controls are well designed and working properly, then it is possible to rely on the books maintained by the assessee. The scope and the extent of the audit can be reduced in such a case. The reverse would be true if the internal controls are not reliable. It is essential to test the application of internal controls in practice to judge and form an opinion about how effectively the prescribed procedures are actually followed. This study will enable an auditor to assess the level of compliance and level of reliability of the prevalent internal control system. [i] Walk-through One of the ways of evaluating internal control is to do a 'walk through'. Undertaking a 'Walk-through' and conducting ABC analysis during this process helps the auditor to evaluate the system of internal control in a scientific manner. 'Walk-through' is a process by which the auditor selects any transaction by sampling method and traces its movement from the beginning through various sub systems. The auditor verifies this transaction in the same sequence as it had moved. By this method the auditor can get a feel of the various processes and their inter linkages. The auditor can undertake walk through process of sales, purchase, excise, account adjustment systems etc. [iii] ABC Analysis In order to filter out the irrelevant or relatively insignificant data, various techniques are applied and ABC Analysis is one of such data management technique. In ABC analysis the whole data population is classified into three categories based on the importance. A-category is the class of data that is most important from the point of view of managing and controlling the same. B-category is the class of data, which should invariably be controlled, but the degree of control is not as intense as for A- category. C- Category is the class of data, which has much less revenue-implications and can be controlled by suitable test-checks: The auditor can apply ABC Analysis specially in case the quantum of data/information to be analysed is voluminous. As a result of the observations and test carried out, the auditor has to evaluate as to how far he can rely on the internal control system. He should assess whether the control procedures as prescribed and applied in practice are effective in preventing or detecting material errors and irregularities in the accounting system. This is essentially a question of a best judgement in a particular situation. If there exist certain errors or infirmities in the system, he should try to adjudge the impact of the same on tax compliance. Based on the evaluation, the auditor will grade the soundness of the level of internal control of each sub-system as 'reliable, "adequate" or "poor". Thus, evaluation of Internal Controls is important as it helps in mining the scope and duration of the audit. 5. Revenue Risk analysis. Having assessed the reliability of company's accounting records, the next is to assess the "potential" risk to the revenue. If the risk is low, i.e. r records are accurate; the extensive tests may not be required. There are several methods to assess the revenue-risk, such as, comparison of the derived [from financial records] dutiable clearance and tax liability vis-à-vis clearance shown and duty paid. 6. Trend analysis. This is an important step in assessing a company's accounting records. Analysis various trends will help highlight unusual situations or abnormal trends. Trend analysis involves comparing operations from year to year and comparing with other units in the same sector. 7. Developing the Audit Plan. This is one of the most significant steps in the audit programme. The auditor assesses all the information gathered about the assessee and develops a plan to examine detailed records related to the areas where material problems are indicated or foreseen. The Audit Plan is documented in the Working Papers. They should ensure that it is consistent with the complexity of the unit, materiality, problems risk factor identified up to this point and the reasons for selection of the unit for audit in the first place. The draft Audit Plan is submitted for approval of AddL/Joint Commissioner [Audit] and the audit is undertaken only after such approval. 8. Tour of the Premises/Plant This is used to gather information about the systems. A physical tour provides confirmation of much of the information gathered during previous steps and it also helps resolve issues noted earlier. Often, the tour brings out operations and technical details about inputs used and products/by products/wastes manufactured, some of which may not have been discussed during the discussions. It provides clues about important aspects of the operations of the unit. If necessary the auditor speaks to the plant manager or foreman during the tour. 9. Verification This is the detailed verification as per Audit Plan. Entry in the working paper is made for each item of the Audit Plan. At the end of each entry in working paper, .auditor indicates the objections and his findings. If any of the planned verifications is not conducted the reasons thereof is recorded. Audit objections raised must be fully supported by documentary and legal evidence. This will greatly help in explaining and discussing the objections with the assessee and other follow up action. 10. Summarising Audit Findings. This step involves putting together all of the audit findings in one place to be placed in the audit file. Where necessary, important objections and findings are reviewed with the immediate supervisor before discussing them with the assessee. 11. Informing the Divisional Deputy/Assistant Commissioner of major audit points. If the audit party detects a major audit points involving short levy/short payment, which requires immediate attention of the jurisdictional officers including time-bound proceedings for recovery of the dues, the head of the audit party discusses the issue with the Divisional Deputy/Assistant Commissioner This is done immediately after completion of the audit of the unit to bring all such points to the notice of the Deputy/Assistant Commissioner in-charge of the Division. 12. Reviewing results with the Assessee. It is important that the auditor informs the assessee of all the objections before preparing draft Audit Report, The assessee must have the opportunity to know the objections and to offer clarifications with supporting documents. This process will resolve potential disputes early and avoid unnecessary disputes. 13. Compliance of Audit objections. Where the assessee is in agreement with the audit findings, in part or in full, the auditor requests that payments be made promptly to stop accrual of interest. Voluntary compliance should be encouraged so as to avoid protracted legal wrangles. Attention of the assessee is invited to sub section [of Section 11 A of the Central Excise Act, 1944. 14. Future Compliance. This is the final step before the auditor leaves the assessee's premises. The auditor discusses with the assessee, steps to improve compliance including systemic improvement and modifications in the legal arrangements. 15. Reporting. The draft Audit Report is completed at this stage after the auditor has recorded all the findings against each of the detailed audit steps. All the Working papers are included as attachments to the final Audit Report. 16. Audit Follow up: After the submission of the Audit Report along with the Working papers, • The Superintendent in-charge of the audit team discusses the major audit points with Assistant/Deputy Commissioner audit. After preliminary discussion the action points are identified by the audit team. • The Audit Report is submitted for evaluation to the Audit Cell. • The Audit Cell evaluates the Audit Report and score each report as per the instructions of the Board. [Circular No. 514/10/2000-CX dated 16.2.2000] • This Cell, headed by the Commissioner, during its monthly meetings reviews the Audit Reports for final acceptance or non-acceptance) of the audit points. Thereafter the draft Audit Report is finalised by the Audit Cell. • The minutes of the meeting of the Audit Cell clearly states the required action to be taken in respect of each of the audit points. • The Audit cell updates the Assessee Master file based on the information available in the Audit Report. • The audit section maintains Registers of Audit Planning and Audit Follow-up in prescribed format until the closure of the audit point either by issue of a show cause notice and recovery of dues or by non-acceptance of the audit point by the Audit cell. Computer Assisted Audit Programme Large number of companies have started maintaining their records in electronic format [companies are paperless]. These companies have global perspective and are competing internationally and have huge volume of records. The system of manual audit is not adequate to handle the auditing of such assessees. Auditing of their records require understanding of not only the mounting systems but also computer skills to read and process date files. The auditors need to be equipped to interrogate the data in electronic format. The Computer Assisted Audit Programme [CAAP] is a method of audit of such assessees. By using CAAP, the auditor analysis the business system of the assessee, understands the systems flow chart, computer programming flow d the layout of the files and finally determine the data transfer mechanism. The linkages and discrepancies in the assessee data are detected for the purposes of identifying and narrowing down the possible areas of tax non compliance, which helps in conduct of EA 2000 audit. After downloading the assessees data files the auditor prepares these files so as to make them readable for the audit software. The WINIDEA software is used to perform various functions on this data like, File Stratification, Joining of data bases, Extraction of selected portion of data bases, detection of missing invoices or duplicate series etc. Essentially this software allows the auditor to interrogate and analyse data for audit purpose. Thereafter, the steps are the same as those in EA 2000 audits. The CAAP has been started on experimental basis in few selected Commissionerates. For further details on EA-2000, the Audit manual issued by Directorate General of Audit may be referred to.