replace initiative, ingenuity and judgment in applying, adapting and improvising as necessity warrants.
The following sections briefly describe the books, records and detail that the auditor will normally encounter in making audits. All or part of these described records may be used in performing any given audit and they may be used in either a direct or indirect audit approach.
EXAMINATION OF GENERAL LEDGER ACCOUNTS
0406.10
The general ledger accounts must be examined for debits and credits which may represent unreported taxable transactions. As examples, sales of merchandise at cost may have been credited to the purchase or inventory accounts; sales of by-products may have been credited directly to profit and loss, surplus or expense accounts; sales of furniture, equipment and other capital assets may have been credited to equipment, depreciation or other accounts. Debits to general ledger equipment and supply accounts may represent unreported purchases subject to use tax.
EXAMINATION OF GENERAL JOURNAL
0406.15
Transactions not disclosed by examination of other records may sometimes be disclosed by examination of the general journal. The auditor should examine general journal entries noting those which may indicate unreported taxable transactions.
All data pertaining to these entries should be examined; such as, correspondence, contracts, invoices and other documents to determine whether the entry represents an unreported taxable transaction.
EXAMINATION OF CASH RECEIPTS AND DISBURSEMENTS RECORDS
0406.20
The cash receipts record should be examined to determine that receipts from cash transactions have been credited to the proper sales or revenue accounts. Care should be exercised not to duplicate taxable transactions disclosed in the examination of other records.
EXAMINATION OF ACCOUNTS RECEIVABLE LEDGER
0406.25
The accounts receivable with the owners, partners, officers, or employees of the company should be examined for evidence of taxable transactions not otherwise recorded in the sales or revenue accounts. Partners’ drawing accounts and employees’ advance accounts should be examined.
EXAMINATION OF PURCHASE JOURNAL
0406.30
Entries may be made in the purchase journal for sales at cost or returned merchandise. Inventory withdrawals which should have been reflected in the inventory accounts may appear as credits in the purchase journal. These postings should be scrutinized for taxable transactions.
January 2000
SCHEDULE OF TOTAL SALES OR REVENUE
0406.35
Unnecessary scheduling should be avoided. However, good auditing procedures should always be kept in mind. Time can usually be saved by reconciling the sales or revenue reported to the general ledger accounts. Taxable differences, where encountered, can be transferred to the Schedule 414–A2, Summary of Differences, when conducting a total sales or Line One audit. In some cases, it is more practical to trace the reported figures to the sales or revenue journal or general ledger by periods. If there are frequent differences appearing, it would be advisable to schedule total sales or revenue. If there are only a few isolated differences, the periods where the differences occur should be scheduled. When the recorded figures can be used in tying-in several items such as total sales and several deductions, a detailed schedule of total sales may be advisable. This may be scheduled from the sales journal if the segregation between taxable and nontaxable sales are not shown in the general ledger.
Where the sales are scheduled from the sales journal or other detailed sources, the scheduled figures should be reconciled with the general ledger.
In all cases, proper planning is necessary to determine the correct method to be used for the assignment. Verification comments should always indicate the general method of reconciliation used.
GROSS PROFIT AND NET WORTH ANALYSIS
0406.40
The auditor will encounter some cases where the taxpayer has no records of any kind, or perhaps only fragmentary records. Where this condition exists, sales must be estimated as accurately as possible based on whatever information is available. In order to estimate sales, it must be assumed that gross profit equals increases in capital assets, operating expenses, and net withdrawals of the proprietor. Algebraically, this is expressed as follows:
(a) Gross Profit = Sales minus Cost of Goods Sold (b) Cost of Goods Sold = Gross Profit ÷ by Mark-Up % (c) Mark-Up Percentage = Gross Profit ÷ Cost of Sales
(d) Gross Profit = Capital Asset increases + Expenses + Withdrawals
(e) Sales = Cost of Goods Sold + Capital Asset increases + Expenses + Withdrawals The items to be determined are:
• Percentage of mark-up
• Capital asset increases, operating expenses and withdrawals.
The percentage of mark-up may have to be estimated based on auditor’s knowledge of mark-ups of similar type and size of business located in the same general area. If at all possible to do so, a mark-up should be computed based on current purchase invoices which may be available. This mark-up could then be compared to the known mark-up of similar businesses as a test of its accuracy.
Increases in capital assets, operating expenses and the proprietor’s net withdrawals must be compiled from data and estimates based on information derived from questioning the taxpayer and other persons who have knowledge of the business. Information regarding increases in capital assets may be obtained by noting new equipment, machinery, etc., and determining the equity held by the taxpayer, etc. Average operating expenses may be estimated from canceled checks of records of expenditures; wages may be taken from social security records; rent from rental agreements. Withdrawals by the proprietor may be estimated from canceled checks, bank deposit books, investments, etc.
January 2000
MARK-UP BASED ON INCOME TAX RETURNS
0406.45
In many instances, income tax returns are no more accurate than the records from which they are compiled. The income tax returns, however, may be of aid to the auditor in supporting sales estimated by using one of the methods outlined above. For example, where the taxpayer’s records have actually been lost or destroyed, the income tax returns may be compared with the sales estimated by using procedures set forth in section 0406.40. This procedure is, of course, based on the premise that at the time the income tax return was compiled the taxpayer was in possession of their records. Where there is a discrepancy between the purchases and sales per the records and the purchases and sales per the income tax return, the taxpayer should be requested to account for such differences. Consideration must be given to purchases and receipts which do not represent sales of tangible personal property.
INCOME TAX RETURNS AS BASIS OF AUDIT
0406.50
Where a taxpayer has acceptable records, but gross receipts recorded in the books and reported on business tax returns are not in agreement with gross receipts on the income tax returns, these differences should be reconciled if possible. In making this reconciliation, differences due to netting of, for example, sales tax from gross receipts per the sales tax return should be recognized. Another example of this would be reporting for income tax purposes on a cash basis vs. an accrual basis for sales tax purposes.
EXAMINATION OF SALES OR REVENUE INVOICES
0406.55
Sales or revenue invoices usually represent the original record of a transaction after an order of execution, such as a purchase order has been given. In the process of most of our audits under the various tax acts, it is a necessary part of the audit procedure to examine a representative number of these invoices to determine how the transaction is recorded thereon and in the case of reimbursable taxes, on what the tax was accrued.
Following is an itemization of the various functions involved in the examination of this original detail:
(a) Postings. This is the first step in the verification of the accuracy of the books of original
entry. The invoice, sales or revenue, is vouched directly to the sales or revenue journal for accuracy of posting relative to amount and classification in the journal.
(b) Tax accrual. On those taxes subject to reimbursement (i.e., sales and use tax), the tax
as accrued on the invoice is important for reasons such as:
• Accrual of the tax based on the measure, i.e., sales tax rate times the selling price. This would relate to audits verifying the taxpayer’s reporting on an accrual of tax basis, and
• The provisions of Regulation 1700 of the Sales and Use Tax Law concerning excess tax reimbursement.
(c) Deductions. At the time the invoice is being reviewed for posting accuracy, etc., it also,
will be reviewed for evidence of exemption or non-taxability. For example, if a sale is being claimed as an exempt sale for resale, the resale certificate itself could be examined at that time.
examinationof salesor revenue invoiCes (Cont.) 0406.55 (d) What is the form of the invoice, i.e., are the charges segregated; are they lump sum
charges, etc.? The importance of this will relate to the particular tax act. For example, sales tax vendors are, under certain conditions, allowed to bill lump sum where they consider themselves to be consumers rather than retailers of the property used in repairing tangible personal property.
In summary, it cannot be overemphasized that the sales or revenue invoice is of prime importance in the audit process and any information found thereon is worthy of consideration; the importance then extends from the document itself to what is done with it in the process of recording.