Section 44AD Audit Requirements: Understanding Balance Sheets, P&L Statements, and Books of Accounts

Section 44AD

An audit should be carried out if your net business profit is lower than 6% of your total turnover. This includes speculative and non-speculative activity, but excludes income from salaries, capital gains and other sources. As such, getting the books audited may become necessary in the event that you are trading as a business but have incurred losses.

It is important to be aware that if your turnover is less than Rs 5 crore (was Rs 2 crore prior to FY 19/20) and the profit you make is below 6% of turnover, an audit will not be mandatory if your total tax liability for the year is zero. That means if your total income (Salary + Business income + capital gain) does not exceed the minimum tax slab of Rs 2.5 lakhs, then there won’t be a requirement for an audit. Nevertheless, it’s reasonable to submit a return with audit when losses are significant.

When you declare trading as a business income, ITR3 has to be used for filing. The same method that applies to other businesses needs to be implemented – making and storing records.

o   Balance Sheet

o   P&L statement

o   Books of Accounts

As previously mentioned, turning over 5 Crore or less and having profits that are lower than 6% of the total turnover require auditing. Those individuals engaged solely in trading have an easy time creating a balance sheet, P&L statement, and keeping books of account; the process is explained briefly below.

– Balance sheet, P&L, Book of accounts

Balance sheet

A personal balance sheet gives a comprehensive overview of your wealth at any given moment. It summarizes your assets, debts, and total worth (assets minus debts).

Creating a personal balance sheet is fairly simple first pull together all of this information:

o   Your latest bank statements

o   Loan statement,

o   House loan statement

o   Personal loan statements

o   Principal balance of any outstanding loans

o   Demat holding statement

Once you have all of that information available, start developing your balance sheet by listing all of your assets (financial and tangible assets) with its respective values. Typical examples of the assets could be –

o   Cash (in the bank, in hand, deposits with Bank)

o   All investments (mutual funds, Shares, Debt investment )

o   Property value ( Cost of Purchase + Duty any paid + Interiors etc)

o   Automobile value ( Motor Car + Two-wheeler )

o   Personal Property Value ( jewelry, household items, etc)

o   Other assets ( Computers, Loans to friends, a plot of land, etc)

The sum of all of those values is the total value of your assets.

Next, you can look at your liabilities, which should be everything you owe. Here are some common liability categories:

o   Remaining mortgage balance (Loan Statement)

o   Car loans

o   Student loans

o   Any other personal loans

o   Credit card balances

The sum of all of the money you owe is your liabilities.

The difference between your assets and your liabilities is your net worth.

That’s it; this is your balance sheet. Instead of waiting until the end of each financial year to make one, consider keeping it up-to-date every couple of months.

Profit & Loss statement

Profit and loss statements provide an overview of your income and expenses for the fiscal year.

To create your P&L for the given Financial Year, you will have to list down all revenues and expenses.

Revenue –

o   Realised sale value from your stock holdings (Capital gains)

o   Income generated from F&O, intraday, or commodity trades can come in the form of both speculative and non-speculative business activities.

Remember that you can’t add your salary income (if you are working elsewhere) into your revenue stream on the P&L.

Expenses –

o   If you have people assisting in your trading activities, they will likely receive a salary.

o   If you are using an office or any space for the purpose of trading, it may require a rental payment.

o   Brokerage charges, taxes, and all other trade-related expenses.

o   Advisory fees, consultancy, depreciation of computer, and etc (read the expenses section in the chapter on taxation-traders)

Revenue minus the Expense equals profit.

A Balance sheet and Profit & Loss statement can be used to comprehend your net worth between two periods of time, as well as shed light on any increases or decreases in wealth. Keeping up a financial discipline is paramount for creating lasting wealth. By staying connected with a personal balance sheet and P&L you can remain aware of your assets and liabilities.

Book of accounts/Book-keeping

Maintaining a book of accounts and bookkeeping can seem intimidating, but for traders dealing with business income, salary or both, they couldn’t be simpler: just maintain two books! I’ve seen many people scared off by the prospect, but there’s no need to worry – and no need to procrastinate on learning more on the topic.

Bank book: Having a bank book can be extremely beneficial. By downloading your bank statements to an Excel Spreadsheet and noting each transaction, you make data organisation easier. Additionally, keeping copies of bills pays off in the event of expenses.

Trading book: It is your broker’s responsibility to keep your trading book up to date. They should be able to provide you with a P&L statement including expenses for the year, as well as a ledger statement and digital repository of contract notes that are available on request. It is generally not necessary to have hard copies of the contract notes unless requested by the IT department.

Having traded with over 10 online brokers in India, I can confidently attest that a ledger and P&L statement with all expenses included will highlight any potential hidden charges.