Auditing and Accounting challenges in Nepalese SME

Over the last several months, I got several opportunities to interact with small and medium tax payers and registered auditors, based in different districts of Nepal. We were working as resource person for a couple of assignments related with tax payer education program, a pilot project of GIZ RAS,  and capacity building initiatives of ICAN for registered auditors. Some of my observation relating to SME was published in my earlier blog post, “The Tax plights of micro SME.” Here I have tried to highlight two major issues on accounting and tax reporting, as reflected in our interactions.

1. The accounting standard and tax law dilemma

The capacity of Registered Auditors, tax payers and tax officers in understanding and implementing tax law and accounting principles is one of the biggest challenge. There are several major areas where tax law provisions and accounting principles differ. The invoicing requirements of VAT law too are not harmonized with accounting standards. Both the Registered Auditors and revenue officers, however, try enforcing reporting of same figures in financial statement and tax returns. Any differences in income statement and VAT records are taken in a suspicious note.  Adjustments shown through reconciliation statement are often not accepted. There are several areas where clarity are needed for proper implementation of accounting norms and tax assessment resulting out of this. For e.g. the treatment of biological assets.

The practice differs from person to person, from tax office to tax office.  Tax office interpretations are more revenue focused, and auditors and tax payers prefer financial statement that satisfies the tax officer’s requirement which itself is not principally correct. The dispute resolution mechanism too is not transparent, independent and practical, and so tax payers prefer settlement of tax disputes in the tax office itself, rather than appeal.

2. Are the Financial Statements true and fair?

It is evident to everyone that businesses in Nepal, especially in SME sector, are reluctant in providing invoice or disclosing the actual sales price. The problem begins from the custom point where import invoice are under-invoiced for custom purpose, and later sales to customers cannot be recorded at actual price with the fear of disclosing higher profit margin. Hence, businesses maintain dual books of accounts, with tax returns aimed at satisfying tax law requirements and paying pre-determined amount of tax, instead of the actual results.

The only businesses exempt from audit requirement are firms with turnover less than Rs. 5 million. Tax returns in all cases are required to be certified by auditor, including mandatory audit of all companies, NGO and Cooperatives, irrespective of size.  Not all can businesses afford to hire a full time accountant and so businesses rely heavily on their auditors.

Lack of proper invoices & records means accounts does not portray correct pictures. Businesses maintain incomplete records, which are passed on to auditors for preparing financial statements and make tax calculations. This results in self-review threat and is not recommended. But businesses consider auditors responsible for preparation of financial statement and certifying correctness of their tax affairs. As a result, auditors cannot implement the expected audit standards while discharging audit functions. On other hand, they can always be held liable for that and so live with Damocles sword hanging over them any time.

The perception of Revenue Authorities and the general public too is not in favor of auditor, believing that auditor’s play a role in assisting tax avoidance/evasion by tax payers. This might be right in some cases, but it’s not just the auditors who can be blamed for the situation. The whole mechanism operates in a similar fashion, beginning from custom office. In the end, its the auditor who is sandwiched due to the independent role he was expected to perform during process of certifying tax return and providing audit opinion.


The accounting and tax issues among the SME should be considered from a holistic approach.  Reforms are needed in the practice of custom office, and in tax office. While the tax payers are penalized for any errors, the assessing officers do not have any liability on their own. Proper guidelines should be developed for books of accounts and tax assessment such that subjective interpretations by assessing officers are minimized.  The provision of turnover tax law should be improved to make it more practical. And above all, regular capacity building programs are needed both for auditors, tax officers and tax payers.  These system improvements can be achieved only with a joint effort from all the regulatory bodies.