Conduct of audit on the basis of Xerox copies of records when

the records are seized by the Income-tax Department.

1.A group of companies was subject to a search operation u/s 132 of the Income-tax Act, 1961, by the Income-tax Department during September, 1988, which was concluded in December, 1988. Almost all the accounting records, such as books of account, stock books/ kardox, voucher files etc. pertaining to earlier years as well as the current year upto September, 1988, were seized. The accounting year of most of the companies was June ending, which has been extended by three months upto September, 1988.

2.The companies would be obtaining Xerox copies of all the records (books, vouchers etc.) seized by the Income-tax Department. Some books are available on the computer and the company will have these books reprinted. The accounts for the year ending September, 1988 would be finalised/audited on the basis of such Xerox copies of books/vouchers. For the purpose of finalising the accounts and the audit thereof, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether accounts finalised/audited on the basis of Xerox copies of books and vouchers can be called “true and fair”?

Specifically, should the auditor: -

(a) Merely give an explanatory not to the accounts stating that the accounts have been made up on the basis of Xerox copies of books and vouchers or,

(b) Qualify the audit report stating that “subject to the audit being made on the basis of Xerox copies of books/vouchers seized by the Income-tax Department u/s 132 of the Income-tax Act, 1961, the accounts show a true and fair view” or

(c) Refrain from expressing an opinion by stating that “I am unable to express an opinion whether the accounts show a true and fair view of …….since the original books/vouchers have been seized by the Income-tax Department u/s 132 of the Income-tax Act, 1961, and the accounts annexed thereto have been made upon the basis of Xerox copies of such books/vouchers seized.”

(ii) Since it would not be possible to ascertain the liability for Income-tax on account of the matters that will come to light on account of the search operation, should the auditor:

(a) Give an explanatory note, or

(b) Qualify the report, or

(iii) What would, in general, be the professional responsibility of the auditor under such circumstances while performing the audit of current year?

Opinion September 13, 1989

1.The Committee notes that in the conduct of an audit, obtaining audit evidence through examination of records and documents is of crucial importance. The auditor, therefore, strives to obtain such evidence which is appropriate in terms of its relevance and reliability. In this regard, the Committee notes that para 12 of the Statement on Standard Auditing Practices (SAP)-5 on ‘Audit Evidence’ issued by the Institute of Chartered Accountants of India, states as below:

“Inspection consists of examining records, documents or tangible assets. Inspection of records and documents provides evidence of varying degrees of reliability depending on their nature and source and the effectiveness of internal controls over their processing. Four major categories of documentary evidence, which provide different degrees of reliability to the auditor are:

- documentary evidence originating from and held by the third parties.

- documentary evidence originating from third parties and held by the entity.

- documentary evidence originating from the entity and held by third parties and

- documentary evidence originating from and held by the entity.”

2.The Committee notes that in the present case only Xerox copies of all types of above documentary evidence are available to the auditor. The degree of reliance which can be placed by the auditor on such audit evidence will be considerably increased if the Xerox copies of account books and vouchers are certified to be true copies by the Income-tax Department. If the tax authorities refuse to certify the Xerox copies to be true copies, the auditor should get the certificate, to this effect, from the management of the company. However, in this case, the degree of reliance which can be placed by the auditor would be considerably less. The auditor should use procedures like confirmation of balances from third parties, inspection of tangible assets, observation of various processes or procedures being performed by the client’s personnel, e.g., counting of inventory items, analytical review procedures, making inquiries from the personnel within the entity and outside it, compliance procedures with regard to internal controls etc., and gather evidence which corroborates or refutes the documentary evidence available. The Committee is of the opinion that it should be open to the auditor to complete the audit of the accounts on the basis of such Xerox copies of books and vouchers. The auditor should, however, qualify his report clearly stating that audit has been conducted on the basis of Xerox copies of books of account and vouchers seized by the Income-tax Department and the Xerox copies have been authenticated by the Income-tax Department/management of the company.

3.The Committee notes that Accounting Standard 4 (AS4) defines ‘Contingency’ as:

“A condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence or non-occurrence of one or more uncertain future events”.

Further, paragraphs 10 and 11 of Accounting Standard 4 (AS4) state as follows:

“10. The amount of contingent loss should be provided for by a charge in the statement of profit and loss if:

(a) It is probable that at the date of financial statements, events subsequent thereto will confirm that (after taking into account any related probable recovery) an asset has been impaired or a liability has been incurred as at that date, and

(b) A reasonable estimate of the amount of the resulting loss can be made.

11. The exercise of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met unless the possibility of loss is remote”.

4. The Committee is of the opinion that in the present case, no tax demands have been raised and no tax evasion has been detected so far. Since the ultimate outcome will be known and determined on the completion of the investigation in this regard, the liability which may arise, therefore, is a contingent liability. Since a reasonable estimate of the amount of liability cannot be made, disclosure in this regard should be made, unless the possibility of loss is remote as required in Para 11 of AS 4. If this is done then the auditor should not qualify his report.

5.The Committee is of the opinion that the auditor should, as a part of his professional responsibility, exercise reasonable skill and diligence to comment on the authenticity of the financial statements. He should use procedures which have been discussed in para 2 to gather evidence which corroborates or refutes the documentary evidence available.

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