Clause 40 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Clause 40 reports five ratios for the previous year and the preceding previous year — total turnover, gross profit to turnover, net profit to turnover, stock-in-trade to turnover, and material consumed to finished goods produced.
From the ICAI Guidance Note on Tax Audit (Revised 2026), the concluding edition under the Income-tax Act, 1961. For tax years under the Income-tax Act, 2025 the particulars move to Form No. 26 under rule 47 of the Income-tax Rules, 2026.
The table clause 40 prescribes
| S. No. | Particulars | Previous year | Preceding previous year |
|---|---|---|---|
| 1 | Total turnover of the assessee | — | — |
| 2 | Gross profit / turnover | — | — |
| 3 | Net profit / turnover | — | — |
| 4 | Stock-in-trade / turnover | — | — |
| 5 | Material consumed / finished goods produced | — | — |
The details are required for principal items of goods traded or manufactured or services rendered.
Who has to furnish which ratios
Paragraph 75.1:
- The ratios have to be calculated for assessees engaged in manufacturing or trading activities;
- except ratio No. 5, which need not be furnished for a trading concern — a trader produces no finished goods, so the ratio has no denominator;
- in respect of a service provider, only the information at S. No. (1) and (3) need be furnished — total turnover and net profit to turnover.
The first TAQRB finding on clause 40 is that where the clause was not applicable, particularly for service sector entities, "Not Applicable" was not reported and the clause was left blank. A service provider does not simply omit rows 2, 4 and 5 — it states that they are not applicable, so the reader can tell a considered omission from an oversight.
What the terms mean
Paragraph 75.2: while calculating these ratios, meaning has to be assigned to the terms used having due regard to the generally accepted accounting principles, and all the ratios mentioned in this clause are to be calculated in terms of value only.
| Term | Guidance Note definition |
|---|---|
| Gross profit / gross margin | "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." A negative result is a gross loss |
| Sales turnover | Attention is invited to "Sales, Turnover, Gross receipts" in para 5 of the Guidance Note |
| Net profit | "The excess of revenue over expenses during a particular accounting period." A negative result is a net loss. The net profit to be shown here in this clause is net profit before tax |
Ratio 4 — stock-in-trade to turnover
Paragraph 75.3 fixes three things at once:
- Only closing stock is to be considered — not average stock;
- "stock-in-trade" does not include stores and spare parts or loose tools; and
- it would include only finished goods and would not include the stock of raw material and work-in-progress, since the objective is to compute the stock-turnover ratio.
The TAQRB found the first of these breached directly: "the stock-in-trade/turnover ratio was computed using average stock instead of stock as prescribed in the Guidance Note."
Ratio 5 — material consumed to finished goods produced
Paragraph 75.4: material consumed would, apart from raw material consumed, include stores, spare parts and loose tools.
This is the trap in clause 40, and the TAQRB caught both sides of it: "the amount of material consumed reported under this clause did not include stores, spares, and loose tools in certain cases". Stores, spares and loose tools are excluded from stock-in-trade in ratio 4 and included in material consumed in ratio 5. The same three items, two opposite treatments, one clause.
Paragraph 75.5 gives the formula for the denominator:
| Value of finished goods produced | |
|---|---|
| (a) Raw material consumption | — |
| (b) Stores and spare parts consumption | — |
| (c) Wages | — |
| (d) Other manufacturing expenses — excluding depreciation | — |
| Sub total | — |
| Add: Opening stock in process | — |
| Deduct: Closing stock in process | — |
| Value of finished goods produced | — |
Note that depreciation is excluded from other manufacturing expenses, and that work-in-progress is adjusted at both ends.
Showing the computation
Paragraph 75.6: under clause 40, calculation of the ratios is also to be stated — so the computation of the various components on which the ratios have been worked out is required to be stated. However, if any of those components is stated in the financial statements themselves, a reference to the same may be made, to the extent possible.
Paragraph 75.7: there should be consistency between the numerator and the denominator while calculating the ratios, and any significant deviation should be pointed out in para 3 of Form 3CA or para 5 of Form 3CB.
The preceding previous year column
Paragraph 75.8: the relevant previous year figures are to be taken from the last previous year audit report, or the reinstated figures, to make the ratios comparable with the current year. Where the preceding previous year is not subject to audit, nothing should be mentioned in the relevant column and the same should be disclosed in the observation para of Form No. 3CA or Form No. 3CB.
The TAQRB found the corresponding failure: "mismatch in figures relating to material consumed for the preceding previous year was noticed; however, no corresponding observation or qualification was reported in Form No. 3CA/3CB." A restatement is permitted; an unexplained mismatch is not.
The five TAQRB observations in full
- "Not Applicable" not reported where the clause did not apply, particularly for service sector entities — the clause left blank.
- Scrap sales not considered for reporting under this clause in certain cases.
- Net profit after tax incorrectly reported instead of net profit before tax.
- Stock-in-trade / turnover computed on average stock instead of closing stock.
- Stores, spares and loose tools omitted from material consumed; and the ratio of material consumed to finished goods produced not reported in certain cases.
Worked example
| Item | Treatment under clause 40 |
|---|---|
| Scrap sales of Rs 6,80,000 | Included in turnover — the TAQRB finding |
| Profit before tax Rs 92,00,000; profit after tax Rs 68,00,000 | Ratio 3 uses Rs 92,00,000 |
| Opening stock Rs 40,00,000, closing stock Rs 60,00,000 | Ratio 4 uses the closing stock of Rs 60,00,000, not the Rs 50,00,000 average |
| Closing stock comprises finished goods Rs 60,00,000, WIP Rs 18,00,000, raw material Rs 25,00,000, stores Rs 4,00,000 | Ratio 4 numerator is the finished goods of Rs 60,00,000 only |
| Raw material consumed Rs 3,10,00,000; stores, spares and loose tools consumed Rs 14,00,000 | Ratio 5 numerator is Rs 3,24,00,000 |
| Preceding year not audited | Column left blank and the fact disclosed in the observation paragraph |
| Service provider with no goods | Rows 2, 4 and 5 marked "Not Applicable" |
Audit checklist
- Establish the assessee's category — manufacturer, trader or service provider — and furnish only the applicable rows of clause 40.
- Mark inapplicable rows "Not Applicable"; never leave them blank.
- Use net profit before tax.
- Include scrap sales in turnover.
- Use closing stock of finished goods only for ratio 4.
- Include stores, spares and loose tools in material consumed for ratio 5.
- Build finished goods produced on the paragraph 75.5 formula, excluding depreciation and adjusting WIP.
- State the computation, or cross-refer to the financial statements where the component appears there.
- Keep the numerator and denominator consistent, and flag any significant deviation in Para 3 or Para 5.
- Take the preceding year from the previous audit report or restated figures, and disclose an unaudited preceding year.
Common mistakes
- Leaving clause 40 blank for a service provider instead of marking it not applicable.
- Using net profit after tax.
- Using average stock for the stock-turnover ratio.
- Omitting stores, spares and loose tools from material consumed.
- Restating the preceding year without an observation explaining the change.