RAMO 1-2000

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March 17, 2000

REVENUE AUDIT MEMORANDUM ORDER NO. 01-00

SUBJECT : Updated Handbook on Audit Procedures and Techniques Volume I (Revision —Year 2000)

TO : All Internal Revenue Officers and Others Concerned I. Objective

This Order prescribes the use of the Updated Handbook on Audit Procedures and Techniques (Volume I) in the audit of tax returns. The Handbook is intended to provide revenue officers with minimum standard procedures and a uniform guideline for the proper examination and/or investigation of tax liabilities. This updated version was prepared in order to conform with the provisions of the Tax Reform Act of 1997".

II. Quality Audit

The purpose of auditing a tax return is to determine the taxpayer's substantially correct tax liability. A quality audit is the examination of the taxpayer's books and records in sufficient depth for the purpose of ascertaining the correctness and validity of entries and the propriety of application of tax laws. To ensure quality audit of tax returns, revenue officers are enjoined to utilize their technical skill, training and experience, and follow the minimum audit procedures prescribed in the Handbook under Annex "A" hereof.

III. Reporting Requirements

Revenue Officers are required to make a report after the audit has been conducted. All reports should contain the minimum documentary requirements specified under Chapter XVII of the Handbook.

IV. Repealing Clause

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all revenue issuances and portions thereof inconsistent herewith. V. Effectivity

All revenue officers and other employees concerned are hereby directed to refer to the aforesaid Handbook in the audit/investigation of tax returns

immediately after the approval of this Order. CTSHDI

(SGD.) DAKILA B. FONACIER Commissioner

Bureau of Internal Revenue

HANDBOOK ON AUDIT PROCEDURES AND TECHNIQUES VOLUME I

(Revision - Year 2000)

PREFACE

The enactment of the National Internal Revenue Code of 1997 and its implementation effective January 1, 1998 marked significant changes in Philippine taxation and the BIR's tax administration policies. Hence, it is necessary to revise and update the existing revenue issuances and assessment manuals in accordance with the new provisions of the Tax Code.

In order to utilize audit as an effective tool in the enhancement of voluntary compliance, the first volume of the Handbook on Audit Procedures and Techniques has been revised and updated to conform with the new Tax Code. This volume discusses general procedures and techniques designed to assist the Revenue Officer in the investigation of tax liabilities of taxpayers. The audit procedures and techniques for the investigation of Value-Added Tax liabilities are prescribed in a separate manual.

ACKNOWLEDGMENT

The updating of this Handbook on Audit Procedures and Techniques — Volume I was completed under the leadership of Commissioner Dakila B. Fonacier and Deputy Commissioners Romeo S. Panganiban, Estelita C. Aguirre, Sixto S. Esquivias IV and Lilia C. Guillermo.

This Handbook is a project of the Assessment Service with the Assessment Programs Division as the lead division which spearheaded the project. Acknowledgment is also extended to Atty. Arnulfo B. Romero, Mr. Rodolfo Mendoza and Mr. Manny B. Jimenez for their comments and invaluable contribution to the project.

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ASSESSMENT SERVICE

Nars P. Tamayo Acting Assistant Commissioner

Elvira R. Vera Acting Head Revenue Executive Assistant ASSESSMENT PROGRAMS DIVISION

Leticia C. Batausa Officer-In-Charge Ione S. Alejo Section Chief Elenita V. Balonzo Section Chief Cristina T. Billones Section Chief Urania C. Salvacion Section Chief Gladys M. Aquino Revenue Officer III Dessie V. Garcia Revenue Officer II Elmira C. Viray Revenue Officer I Gean M. Dienzo Computer Operator I Cristina V. Pangan Computer Operator I

Table of Contents I. Introduction

Revenue Tax Administration Purpose

Contents of the Handbook II. Accounting Methods

Cash Basis Accrual Basis

Completion of Contract Basis Percentage of Completion Basis Installment Basis

Crop Year Basis III. Bookkeeping Systems

Single Entry System Double Entry System

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IV. Accounting Records Journal

Ledger

Subsidiary Book

Computerized Accounting System V. Accounting Period

Calendar Year Fiscal Year

VI. Financial Statements Income Statement Balance Sheet

VII. Purpose and Standards of Audit General Standards

Standards of Preliminary Planning Standards of Field Work

Standards of Public Relations VIII. Preliminary Approach to Examination

Pre-audit Analysis of Tax Returns Work Planning

Contact with Taxpayer

Preliminary Evaluation of Miscellaneous Records Initial Examination Techniques

Evaluation of Internal Control Sampling Techniques

IX. Balance Sheet Approach to Examination Cash on Hand and in Bank

Notes and Accounts Receivable Allowance for Bad Debts Inventories

Advances to Stockholders/Officers Investments

Depreciable Assets

Allowances for Depreciation, Amortization and Other Valuations Reserves

Intangible Assets

Prepaid Expenses and Deferred Charges Other Assets

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Current and Accrued Liabilities including Notes Payable Fixed Liabilities

Deferred Credits

Loans From Shareholders/Officers/Owners Capital Accounts

Capital or Owner's Equity Partners' Capital

Stockholders' Equity Capital Stock Retained Earnings X. Audit of Income and Expenses

Audit of Income Accounts Sales

Rent Income Professional Fees

Income From Sale of Asset Other Income

Audit of Expense Accounts Purchases

Cost of Goods Sold

Salaries, Wages and Other Employees' Benefits Fringe Benefits Rents Royalties Interest Taxes Repairs Bad Debts Losses

Abandonment and Demolition Casualty/Theft

Net Operating Loss Carry Over Depreciation

Depletion Contribution

Transportation and Travel, Representation and Entertainment Stationery and Office Supplies

Professional Fees Insurance Fees

Light and Power, Telephone and Telegraph Miscellaneous Expenses

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XI. Audit of Minimum Corporate Income Tax and Improper Accumulation of Earnings Tax

XII. Auditing Computer-Produced Records Impact of Computer Records on Audit Accounting Software Systems

Audit Techniques for Computer-Produced Records XIII. Indirect Approach

Percentage Method Net Worth Method Bank Deposit Method Cash Expenditure Method Unit and Value Method

Third Party Information (Access to Records) Method XIV. Audit Procedures on Other Kinds of Taxes

Withholding Taxes Capital Gains Tax Estate Tax

Donor's Tax

XV. General Policies in the Investigation of Tax Fraud Cases Jurisdiction

Procedures Civil Fraud XVI. Closing Conference XVII. Report Making

Document Locator Form Table of Contents Narrative Report

Duly Accomplished Revenue Officer's Audit Report Working Papers

Attachments to the Docket of the Case Appendix

Revenue Memorandum Order No. 15-95

General Policies in the Investigation of Tax Fraud Cases Revenue Memorandum Order No. 53-98

Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by

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a Revenue Officer, all of which comprise a complete Tax Docket I. INTRODUCTION

A Revenue Tax Administration

The function of the Bureau of Internal Revenue is to administer the provisions of the National Internal Revenue Code. It is the duty of the Bureau to implement the Tax Code and related laws enacted by Congress in a fair and impartial manner.

The mission of the Bureau is to enforce internal revenue laws with impartiality, consistency, collect the correct amount of taxes at the least cost to the government and least inconvenience to the taxpayer and serve the public honestly and efficiently in a manner that will elicit the highest level of confidence in the Bureau of Internal Revenue.

Investigation supports the mission of the Bureau by enhancing a high degree of compliance and encouraging the correct reporting of income, transfer, business and other taxes. This is accomplished by:

1. Measuring the degree of voluntary compliance as reflected on filed returns;

2. Reducing non-compliance by identifying returns and taxpayers that need to be investigated; and

3. Conducting quality audit of selected tax returns on a timely basis.

The purpose of auditing a tax return is to determine the taxpayer's correct tax liability. A quality audit is the examination of a taxpayer's books and records in sufficient depth so as to ascertain the correctness and validity of entries thereon and- the propriety of application of tax laws. ADaSEH

B. Purpose

The updated Handbook on Audit Procedures and Techniques has been prepared to equip all Revenue Officers who conduct field examinations with-the necessary knowledge for the proper examination of tax returns and provide them with confidence in carrying out the investigation. This Handbook is designed to ensure that. the Revenue Officer acquires useful auditing skills, progresses from simple audit techniques to more sophisticated procedures, and advances in examination procedures from a single proprietorship to a large corporation and from a simple bookkeeping system to a highly computerized one.

The Revenue Officer's job is to familiarize himself with the business activity and/or undertaking of the taxpayers assigned to him for audit, to evaluate the various methods and procedures the taxpayers apply, to be imaginative, observant and inquisitive in his examination, and above all, to use common sense.

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C. Contents of the Handbook

The handbook contains guides, instructions and suggestions in the conduct of audit for various taxpayers. The discussions begin with the analysis of tax returns and financial statements, familiarization with accounting methods, bookkeeping systems, books of accounts and other related records. The audit procedures for balance sheet and income statement accounts are laid out together with investigation techniques for each type of tax. This does not preclude, however, the Revenue Officer from carrying out other audit techniques which are deemed necessary in the circumstances surrounding a particular case.

The Handbook is neither intended to provide a source of tax law or procedural doctrine nor a substitute reference material of revenue issuances. Each Revenue Officer is presumed to have a working knowledge of the Tax Code, the latest amendments thereon, and an update of existing revenue regulations, revenue rulings, revenue memorandum orders and other issuances.

The other contents of the handbook include documentary requirements in the investigation process and proper report making.

II. Accounting Methods

The taxable income of a taxpayer shall be computed in accordance with the method of accounting he regularly employs in keeping his books. However, if the taxpayer does not regularly employ a method of accounting which reasonably shows his correct income, the computation of income shall be made in such manner as in the opinion of the Commissioner of Internal Revenue or his -duly authorized representative that clearly reflects such income.

The methods of accounting recognized under the Tax Code are:

A. Cash Basis is a method of accounting whereby all items of gross income received during the year shall be accounted for such taxable year and that only expenses actually paid for shall be claimed as deductions during the year. This method of accounting is generally used by taxpayers who do not keep regular books of accounts. Under this method, income is realized upon receipt of cash or its equivalent including those constructively received (such as deposits for the taxpayer's account by customers) but not including gifts or donations. Users of cash basis accounting are mostly individuals engaged in business and practice of profession, professional partnerships and professional service organizations.

B. Accrual Basis is a method of accounting for income in the period it is earned regardless of whether it has been received or not. In the same manner, expenses are accounted for in the period they are incurred and not in the period they are paid. Under this method, net income is being measured by the excess of income earned during the period over the expenses incurred. Expenses not being claimed as deductions by

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taxpayers in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year. The accrual basis of accounting is being used by taxpayers whose nature of business uses inventories since this method of accounting will correctly reflect income by matching purchases and expenses against sales. This method is being applied by most medium and large corporations. HETDAa

C. Completion of Contract Basis is an accounting method applicable to contractors in the construction of building, installation of equipment and other fixed assets, or other construction work covering a period in excess of one year.

Under this method, gross income is to be reported in the taxable year in which the contract is fully completed and accepted by the contractee if the taxpayer elected it as a consistent practice to treat such income, provided that such method clearly reflects the net income. Under this method, all expenditures, are deducted from gross income during the life of the contract which are properly allocated thereto, taking into consideration any materials and supplies charged to the work under the contract but remaining on hand at the time of the completion.

However, pursuant to Republic Act No. 8424 which took effect on January 1, 1998, contractors are no longer allowed to adopt this method of reporting their income derived in whole or in part from long-term contracts.

D. Percentage of Completion Basis is a method applicable in the case of a building, installation or construction contract covering a period in excess of one year whereby gross income derived from such contract may be reported upon the basis of percentage of completion. In determining the percentage of completion of a contract, generally one of the following methods is used:

1. The costs incurred under the contract as of the end of the tax year are compared with the estimated total contract costs; or

2. The work performed on the contract as of the end of the tax year is compared with the estimated work to be performed.

In such case, the return should be accompanied by a certificate of the architect or engineer showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied.

Beginning January 1, 1998 income from log-term contracts are required to be reported using this method only.

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E. Installment Basis is a method considered appropriate when collections extend over relatively long periods of time and there is a strong possibility that full collection will not be made. As customers make installment payments, the seller recognizes the gross profit on sale in proportion to the cash collected.

F. Crop Year Basis is a method applicable only to farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops are realized.

In relation to the foregoing accounting methods, the Tax Code provides for a tax credit system in computing the tax payable by certain taxpayers. While the tax credit system is not an accounting system, it is discussed here for the proper understanding of the computation of taxes due from taxpayers.

The tax credit system is a method used to account for the creditable taxes deducted by the withholding agents from the income payments to certain payees (as in the case of withholding tax at source pursuant to Revenue Regulations (RR) No. 6-85, as amended by RR 2-98, or the creditable tax added to the sales price (as in the case of value-added tax). The creditable taxes should be clearly identified in the books of the taxpayer, such as:

1. Creditable income tax (asset) 2. VAT input tax (asset)

3. Withholding tax payable-Compensation (liability)

4. Withholding tax payable-Expanded Withholding Tax (EWT) (liability) 5. VAT output tax (liability)

III. Bookkeeping Systems

Bookkeeping may be classified into two systems, namely, (1) the single entry and (2) the double entry.

A. Single Entry System of bookkeeping is basically a type of "net worth" method of arriving at net income. It records only the debit or credit of each transaction, or an account with the debtor or creditor and a simple record of cash receipts and disbursements.

Whenever a system of record keeping does not include equal debit and credit to asset, liability, proprietorship, income and expense accounts, it is referred to AA a "single entry system". The single entry is often used by comparatively simple ventures such as small retail or commission merchants, professional firms, estates and trusts. In many

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cases, the only record of income and deductions consists of entries on the stubs of their checkbooks. Some taxpayers maintain an income tax folder in which they place documents to support their income tax deductions.

A single entry system may be merely a chronological record of transactions posted in a notebook or journal.

Sometimes, the records consist of a complete set of journals (cash, sales, purchases and general journal) and general ledger providing important accounts.

The accounting cycle starts with source documents (invoices, bills, paid checks, loan documents, bank deposit slips, and bank statements) proceeding to the cash receipts and cash disbursements journal, working paper summary and ending with the tax return.

Reconciliation of the taxpayer's books, working paper summary and records to the return is a very important audit step. In this way, the Revenue Officer will become familiar with the taxpayer's accounting system, policies and control procedures. If the records available are organized, this will lend more credibility to the tax return, but if they are inadequate, then the Revenue Officer should closely scrutinize the information on the income tax return. Therefore, when encountered with the lack of formal books and records, the Revenue Officer must use source documents and other available documents to establish the taxpayer's financial position which shall be compared with the taxpayer's standard of living and business activity for validation. HTSAEa

The following formulae for reconstruction of income and expenses may be found useful:

1. Computation of Sales

Cash Sales (cash book) xx Add: Sales on account:

Collections from customers (cash book) xx Less: Accounts receivable (beginning balance) xx Collections from sales for the period xx

Add: Accounts receivable (ending balance) xx xx — — TOTAL SALES xx == 2. Computation of Purchases

Cash purchases (cash book) xx Add: Purchases on account:

Payments to creditors (cash book) xx Less: Accounts payable (beginning balance) xx Payments for purchases for the period xx

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— —

TOTAL PURCHASES xx ==

3. Computation of Expenses

Cash payments for allowable expenses (cash book) xx Add: Prepaid expenses (beginning balance) xx

Accrued expenses (ending balance) xx xx — — Total xx Less: Prepaid expenses (ending balance) xx

Accrued expenses (beginning balance) xx xx — — TOTAL EXPENSES xx ==

B. Double Entry System — Under this system of bookkeeping, accounting recognizes the two-fold effect of every recorded event, the debit and the credit or the object of the event and the equitable interest in that object. Every recorded event affecting one side must necessarily affect the other side. This can be presented in an equation:

Assets = Liabilities + Capital

This can be analyzed into its component elements which show that there are two distinct parties that have right in the assets of the business, the creditors and the owners. The rights of the creditors are the claims of such creditors on the assets of the business which are referred to as liabilities and the rights of the owners on the business are referred to as capital.

In the double entry method, any net increase and net decrease in asset has a corresponding increase and decrease in either liabilities or capital.

Audit of accounting records under this system shall be detailed as presented in the discussions of audit of real and nominal accounts.

IV. Accounting Records

Taxpayers are required by law and regulations to keep and maintain accounting records in sufficient detail to enable them to make a proper return of income. The Commissioner of Internal Revenue is authorized to examine such records or other data which may be relevant in ascertaining the correctness of the tax returns. The books and records kept must be sufficient to establish the amount of the gross income and the deductions, credits and other matters required to be shown in the tax return.

The primary records commonly used by all types of businesses, considering the different accounting systems and reporting methods of the business are invoices,

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vouchers, bills, receipts and other source documents which are also the supporting documents in the selling and buying of merchandise, services and other assets used in the business. For companies which require the use of inventories, the primary records include the detailed inventory list. Other primary records used in financial transactions are the cancelled checks, duplicate deposit slips, bank statements and notes.

The secondary records, regardless of the accounting method used by the taxpayer, include permanent books of accounts and working papers which summarize and list the individual documents including adjustments, when necessary. These records are properly classified in such a way that the taxpayer will be able to determine the financial status of his business in a given period of time and the profit and loss for the period.

All records required to be kept by the taxpayers should be preserved by them for proper administration of any internal revenue law.

Below are the regular accounting records being used by taxpayers:

A. Journal is a book of original entry in which transactions affecting the business of a taxpayer are recorded consecutively day by day as they occur.

Journal consists of the following:

1. Sales Journal. This is a book whereby sales on account are recorded which are supported by sales invoices and which are also the documents that will serve as the basis of recording the transactions in the books of accounts.

Cash sales are usually recorded in the cash book although it may be posted in both books representing a debit to cash in the cash book and a credit to sales in the sales book.

Every entry in the sales journal represents a debit to a customer's account and a credit to sales to be posted in the general ledger.

Sales returns and allowances are also recorded in the sales book which represents a debit to Sales Returns and Allowances and a credit to Accounts Receivable to be posted in the general ledger. This would mean a decrease in Sales and eventually a decrease in an asset account.

2. Purchase Journal. This is a book used to record exclusively all transactions involving the purchase or acquisition of merchandise on account.

The business document that serves as evidence of a purchase transaction is the purchase invoice.

An entry to record charge purchases is a debit to Purchases and a credit to Accounts Payable to be posted in the general ledger.

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general ledger representing a debit to Accounts Payable and a credit to Purchase Returns and Allowances which would mean a decrease in the purchases account.

In certain instances where the volume of business is large and under the Value-Added Tax system, taxpayers maintain subsidiary sales and purchase journals where details of daily sales and purchases are recorded.

3. Cash Book is a book whereby all transactions involving cash such as cash receipts or cash disbursements are recorded.

Types of this book are the following:

3.1 Cash receipts book — a book whereby all transactions involving cash receipts of whatever source are recorded. EHSTcC

3.2. Cash disbursements book — a book whereby all transactions involving cash or check disbursements are recorded.

B Ledger is a book of final entry wherein the classified accounts or items of all transactions entered in the journal are posted. All entries in the journal must be posted to the ledger and shall be classified accordingly so as to show the assets, liabilities, capital and the operating accounts. This will be the basis for the preparation of the balance sheet and the profit and loss statement covering the operation of the business. No entry shall be made in the ledger unless said entry originates from the journal.

The accounts contained in the general ledger provide the Revenue Officer with insight of the operations of the business. When pertinent, the chart of accounts and subsidiary ledgers, if any, should be requested from the taxpayer. If a private ledger is maintained, it should also be requested.

As the Revenue Officer goes through the ledger, unusual or non-recurring items should be noted and verified. Most of these items are classified as follows:

1. Unusual in amount — The Revenue Officer should be alert for month end entries with significant amounts which may affect income and expenses. 2. Unusual by Source — means the books of accounts from where the entry

to the ledger account originates. Hence, expenses or adjustments to income which do not ordinarily originate from the cash journals, sales and purchase books should be investigated. Such adjustments originating from the general journal or journal vouchers should be thoroughly examined as to supporting documents and proper authorization.

3. Unusual by nature — An entry in a ledger account may be unusual by nature as well as by the account itself. Accounts with abnormal balances such as receivable accounts with credit balances may indicate income

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suspense, other receivables, due to stockholders, and such other unusual liability accounts should be analyzed as there may be some income components lodged in these accounts.

C. Subsidiary Book. In the general ledger, accounts are usually transferred and grouped into certain accounts to a subsidiary book. This general ledger account is called control account. Control accounts in the general ledger contain summarized information that is recorded in detail in a subsidiary book or ledger. It is, therefore, the control account which contains summarized information and the subsidiary ledger contains the same information but in detail.

Thus, in order to relieve the general ledger of too many individual accounts, business concerns having numerous accounts with customers and creditors will transfer said accounts to separate ledgers — one for customers and another for creditors. For example, the control account for the customer's subsidiary book will be called "Accounts Receivable", while the control account for the creditor's subsidiary book will be called "Accounts Payable".

All corporations, companies, partnerships or persons required by law to pay internal revenue taxes have the option to keep this kind of book depending on the need of their business, provided that where such books are kept, they shall form part of the accounting records of the taxpayer and shall be subject to the same rules and regulations as to their keeping, translation, production and inspection as are applicable to the journal and the ledger.

D. Computerized Accounting System. This method of accounting is now being used by most companies. It is a system whereby information are fed into the computer thus providing uniformity in the processing of transactions.

Types of System under this method are the following:

1. Simple System. Transactions are easily traced in a small computer system where the primary function performed is the sorting and manipulation of input data and the printing of output reports. There is no loss of audit trail. Audit of this type of system requires little training and background in Information Systems (IS).

An example of this type of system are shipping data that are encoded and processed throughout the system along with accounts receivable ledgers. The output is a multicopy sales invoice for each sale, an updated subsidiary ledger, and a sales journal.

2. Complex System. This is characterized by the batch processing mode, the existence of one Central Processing Unit (CPU) and the extensive use of master files on magnetic media in processing. In this type of system, processing is usually confined to calculations, extensions, summarizations

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and the like. There is some loss of audit trail but the same is not significant. The audit of such system can be done by auditors with limited specialized training in IS auditing. Because of the extent of a printed audit trail, the auditors have the option of performing audit tests with or without the use of the computer based on his experience.

3. Sophisticated System. In this type of system, transactions are initiated within the computer. There is extensive data processing and consequently, a substantial loss of audit trail. Most of the output is in machine-readable form.

Heavily reliance must be placed on internal control in the audit of said system. Since many of these tests require IS skills beyond the knowledge of most auditors, IS specialists are usually called upon by the auditors.

Careful advanced planning is necessary because records needed in audit and the approach to be used in testing must be made before data are processed.

V. Accounting Periods

Accounting periods are generally classified into two. They are: 1. Calendar year; and

2. Fiscal year

A. Calendar Year — is an accounting period which starts from January 1, and ends on December 31. This is used by most taxpayers who elect the calendar year as their accounting period. However, the calendar year shall be the basis of computing the net income in the following cases:

1. when the taxpayer is an individual;

2. when the taxpayer does not keep books of accounts; and 3. when the taxpayer has no annual accounting period.

B. Fiscal year — is an accounting period of twelve months ending on the last day of any month other than December 31.

Corporations and duly registered general co-partnerships are allowed to use this type of accounting period.

A taxpayer may have a taxable period of less than twelve (12) months in the following cases:

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1. when a corporation is newly organized and commenced operations on any day within the year;

2. when a corporation changes its accounting period; 3. when a corporation is dissolved;

4. when the Commissioner of Internal Revenue, by authority, terminates the taxable period of a taxpayer pursuant to Section 6 (D) of the Tax Code; and

5. in case of final return of the decedent and such period ends at the time of his death.

Change in Accounting Period — An individual cannot change his accounting period from the calendar year to the fiscal year. He is only allowed to use the calendar year.

A corporation and a general co-partnership have the option to choose between the calendar year and the fiscal year.

The application for a change in accounting period should be filed in writing with the Commissioner of Internal Revenue, through the Revenue District Office, where the business is registered, within thirty (30) days prior to the date fixed for filing of the return on the basis of the original accounting period designating therein the proposed date for the closing of its new taxable year.

VI. Financial Statements

Financial Statements are reports signifying the end result of the financial accounting process. These reports are as follows:

A. Income Statement — is a report that summarizes the business activities for a given period and reports the net income or loss resulting from operations and from certain other activities. It is variously called the earnings statement, the statement of profit and loss, and the statement of operations. It normally consists of the following sections or items:

1. Sales — reports the total sales to customers and fees received from clients for the period. All sales transactions should be recorded and invoiced. EaISTD

2. Cost of goods sold — refers to cost of goods relating to sales when merchandise is acquired from outsiders. This is the sum of the beginning inventory, purchases and all other buying, freight and storage costs relating to the acquisition of goods and subtracting the ending inventory thereof. When the goods are manufactured by the seller, the cost of goods

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manufactured must first be calculated. This is the sum of the cost of goods in process at the beginning, the cost of materials put into production, the cost of labor applied and factory overhead incurred. The total cost as thus obtained represents the cost of both completed work and uncompleted work still in production. The ending goods in process inventory, then, must be subtracted from this total in arriving at the cost of the product completed and made available for sale.

3. Operating expenses — are expenses incurred or utilized in the course of business or pursuant to the practice of profession. They are generally reported in two categories:

3.1 Selling expenses; and

3.2 General and administrative expenses

In case of self-employed individual taxpayers, professionals, non-resident aliens, estates and trusts engaged in trade or business, general professional partnerships and their individual partners, allowable expenses are subject to the provisions of Section 34 of the Tax Code. However, in lieu of the deductions allowed under the aforementioned section of the Tax Code, an individual subject to tax under Section 24, other than non-resident aliens, may elect a standard deduction in an amount not exceeding ten percent (10%) of his gross income.

4. Other Income and Expenses — include items identified with financial management and miscellaneous recurring activities. Other income include interest and dividend income and income from rentals, royalties and service fees. Other expenses include interest expense and expenses related to the miscellaneous income items reported.

B. Balance Sheet — is a report that shows the financial position of the business unit as of a specified moment of time. It is a status report rather than a flow report. It is variously called statement of financial position, statement of condition, statement of resources and liabilities and the statement of net worth. The balance sheet is the fundamental accounting statement in the sense that every accounting transaction can be analyzed in terms of its effect on the balance sheet. In order to understand the information a balance sheet conveys and how economic events affect the balance sheet, it is essential that the reader be absolutely clear as to the meaning of its two sides in the equation:

ASSETS = LIABILITIES +OWNER'S EQUITY

1. Assets — are economic benefits obtained or controlled by a particular entity as a result of past transactions or events. They include those costs that have not been matched with revenues in the past and are expected to afford economic utility in the production of revenue in the future. It

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includes both monetary assets, such as cash, marketable securities and receivables and non-monetary assets, those costs recognized as recoverable; and hence, properly assignable to revenues of future period, such as inventories, prepaid insurance, equipment and patents.

2. Liabilities — measure the claims of creditors against entity resources. The method for settlement of liabilities varies. Liabilities may call for settlement by cash payment or settlement through goods to be delivered or services to be performed.

3. Owner's Equity — is the residual interest in the assets of an entity that remains after deducting its liabilities. It measures the interest of the ownership group in the total resources of the enterprise. Such equities originally arise as the result of contributions by the owners and the equities change with the change in net assets resulting from operations.

VII. Purpose and Standards of Audit

The basic purpose of tax examination is the determination of correct taxable income as defined by the National Internal Revenue Code and other internal revenue tax liabilities of the person or entity whose return is being examined.

In conducting the examination, the Revenue Officer's responsibility is two-fold: to the taxpayer and to the Philippine Government. Minimum standards of examination may be extended beyond the originally intended scope, or beyond minimum requirements because of situations or facts not apparent at the outset. The extent of verification to be done in any single tax examination is a matter of auditing judgment for which no rigid guide can be established.

The degree of checking or scope of a tax examination may be influenced by an analysis of the taxpayer's accounting procedures and the results achieved therefrom, for they measure the credibility of the records and the degree of the existing system of internal control of the taxpayer.

Standard refers to the criteria by which the quality of performance of auditing examinations are measured.

A. General Standards

1. An impartial mental attitude must be maintained in all affairs relating to an examination in order to assure a fair application of tax laws, regulations and rulings.

2. Professional skill and ingenuity must be exercised in the performance of the examination and the preparation of the report.

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have real merit and only when they will contribute in the proper determination of tax liability.

4. The confidential nature of all information pertaining to any assignment must be strictly observed.

B. Standard of Preliminary Planning

1. Sound judgment should be exercised in selecting from assigned returns those which are most likely to contain areas of non-compliance and, where otherwise permissible, survey procedures should be employed to dispose of those which do not warrant further consideration.

2. Advance planning of work schedules with reasonable accuracy is essential for the effective use of time.

3. A general work plan should be formulated in each case prior to contacting the taxpayer which includes the development of issues suggested by the return and other information. The following steps may be included in the work plan:

3.1 Prepare a list of items which suggest a need for special consideration.

3.2 Draw-up a list of questions to be asked from the taxpayer.

3.3 Identify other agencies or offices where the Revenue Officer can have access to their records if the taxpayer cannot present the documents requested.

C. Standards of Field Work

1. Audits should normally be performed at the taxpayer's place of business because of the accessibility of the books and records and to permit actual observation of taxpayers facilities and scope of operations. Otherwise, it should be performed in the office of the Bureau of Internal Revenue. 2. The use of accounting skills, tax knowledge and ingenuity should be

directed toward recognizing and raising issues which relate to non-compliance areas.

3. Adequate evidential matter should be obtained through inspection, observation, inquiry, analysis and documentation to afford a reasonable basis for consideration of each issue with regard to the position of both the government and the taxpayer.

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adequate authority. D. Standards of Reporting

1. Reports are to be prepared in a complete, clear, concise, and legible manner in order that they may be easily read and understood.

2. Working papers should be legible, in the Revenue Officer's own handwriting, properly labeled, indexed, signed and arranged in a logical and orderly manner. aEIcHA

3. Working papers should be used as a practical and professional tool to aid the Revenue Officer in the discussion of issues or questions with the taxpayer or his authorized representative. It also generally provides a record of the audit procedures undertaken by the Revenue Officer.

E. Standards of Public Relations

1. Initial contact for audit arrangements should be made with the taxpayer and care should be exercised in explaining the type of records required. 2. Revenue Officers must be fully cognizant of the proper sources for

gathering information and of the rights of the taxpayer and his representatives.

3. Necessary time and patience should be devoted to a discussion of any proposed adjustments to ensure that the taxpayer has a proper understanding of the issues.

4. Tact and discretion are required in pointing out errors in books and records in order to avoid discrediting an employee or representative of the taxpayer.

VIII. Preliminary Approach to Examination A. Pre-Audit Analysis of Tax Return

Analysis of the return is essential to an effective audit. Preliminary analysis is used to identify potential issues which will be developed further after contacting the taxpayer. All information contained in any attachment to the tax return should be thoroughly and completely scrutinized to ascertain whether or not all of the information is adequately reflected in the tax return. Before contacting the taxpayer, the Revenue Officer should familiarize himself with the following:

1. The business organization of the taxpayer and whether it has business establishments other than its main or head office;

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2. The location of the business and its branches as this has a relation to the volume of business;

3. The economic activity in which the taxpayer is engaged in; 4. The accounting books and records that would ordinarily be kept;

5. The accounting methods and policies and the degree of internal control; 6. The overall composition of the tax return;

7. The types of income reported; 8. The reasonableness of deductions; 9. Unusual or unfamiliar items;

10. Apparently questionable or unallowable items;

11. Gross profit and selling expense percentage as well as significant variations between prior and current years;

12. Inconsistencies between items and also in the treatment with respect to bad debts, inventory valuation methods, depreciation rates and methods, etc.; 13. Prior years entries in the reconciliation schedules of retained earnings in a

corporate return and of a partner's capital account in a partnership return which affect the year under examination;

14. The status of the retained earnings account as well as the basis of assets and depreciation allowed or allowable; and

15. The report of the tax liabilities of the taxpayer for the immediately preceding period in order to be aware of the deficiencies that were reported. Review of prior year's examination records will clarify some doubts or questions in the Revenue Officer's mind regarding certain items or bring light to situation that otherwise would have remained concealed on the basis of the return alone.

B. Work Planning

Work properly planned achieves good results.

In order to avoid any situation where the Revenue Officer will be faced with a situation of a cramped audit workload and schedule, he should prioritize the audit of the assigned cases in the following manner:

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1. Returns or cases where the statute of limitations is about to prescribe should be given first priority. Prescriptive period is three (3) years counted from the date prescribed by law for the filing of the return, provided that in case a return is filed beyond the prescribed period, the three-year period shall be counted from the day the return; was filed.

2. Claims for refund should be given the next priority in order to develop good BIR-taxpayer relationship.

3. Cases assigned for reinvestigation should also be given priority attention. 4. Returns which would be more productive in terms of revenues should be

given precedence over the less productive ones.

In work planning, an Audit Program should be prepared for each and every case. An Audit Program is a checklist of the various auditing procedures to be undertaken and the various books of accounts, records, documents and business forms to be verified in order to assess the correct tax due from a taxpayer. This checklist would serve as a guide for the Revenue Officer to conduct a "quality audit" within the time frame allowed to conclude a tax audit. It is also a tool of the tax administrators to check on the progress of the tax audit and for proper evaluation of the performance of the Revenue Officer.

C. Contact With Taxpayer

1. Arranging for an Appointment

A telephone or a personal call by the Revenue Officer should be made to the taxpayer himself and not his representative.

2. Serving of Letter of Authority

2.1 On the first opportunity of the Revenue Officer to have personal contact with the taxpayer, he should present the Letter of Authority (LA) together with a copy of the Taxpayer's Bill of Rights. The LA should be served by the Revenue Officer assigned to the case and no one else. He should have the proper identification card and should be in proper attire.

2.2 A Letter of Authority authorizes or empowers a designated Revenue Officer to examine, verify and scrutinize a taxpayer's books and records in relation to his internal revenue tax liabilities for a particular period.

2.3 A Letter of Authority must be served or presented to the taxpayer within 30 days from its date of issue; otherwise, it becomes null and void unless revalidated. The taxpayer has all the right to refuse its service if presented beyond the 30-day period depending on the policy set by top management. Revalidation is done by issuing a new Letter of Authority or by just simply

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stamping the words "Revalidated on _____________" on the face of the copy of the Letter of Authority issued. ASICDH

3. Request for Accounting Records

The Revenue Officer should clearly specify the records he desires to be assembled for his examination. Among the books and records that may be required are:

3.1 receipts (official receipts, warehouse receipts, delivery receipts, etc.) 3.2 invoices (sales and purchases invoices)

3.3 vouchers

3.4 cancelled checks

3.5 bills and statements of accounts (utility bills, payment notices, etc.) 3.6 contracts (sales/purchase contracts, loan contracts)

3.7 journals (regular and subsidiary journals) 3.8 ledgers (regular and subsidiary ledgers) 4. Initial Interview

The initial interview is the most important part of the examination process and should be conducted in all audits.

Request should be made for a personal interview with the taxpayer himself.

The interrogation should be so conducted as to encourage the taxpayer to contribute willingly useful information which will assist in the proper determination of his tax liability. The information developed by this method will determine the eventual outcome of the case. The preliminary interview should, as far as practicable, cover the following:

4.1 Discussion of sources of income — This may uncover possible sources of income which have not been reported such as interests on investments and deposits, dividends, rents, sales of properties as well as information on the taxpayer's financial history and standard of living;

4.2 Records kept for each source of income; 4.3 Handling and recording of cash transactions; 4.4 Records of loans from banks and/or loans to others

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4.5 Real or personal properties bought or sold in current year; 4.6 Correctness of personal and additional exemptions claimed; 4.7 Other items that would be relevant in the examination, to wit;

a. The responsible officers of the firm in order to facilitate acquisition of information/data:

b. Place and time of audit.

c. Ocular inspection of the factory, branches, outlets, etc.; d. Officers to whom the tax audit findings will be discussed; and e. Financial history and standard of living of the owner/owners. D. Preliminary Evaluation of Miscellaneous Records

The investigation on the taxpayer's books of accounts may begin with miscellaneous records other than accounting ledgers and journals. More often than not, scrutiny of these records may reveal items which the Revenue Officer should take into consideration as the examination progresses. The records and information to be obtained are the following:

1. Minute Book

The review of the minute book should not be confined to the taxable year under audit but should cover at least some period immediately before or after. As the Revenue Officer scans the minute book, he should note appropriate transactions and items of significance, such as contracts entered into by the taxpayer, stock issuance, dividend declaration and compensation of officers.

2. Stock Transfer Book

This book contains the names of stockholders, past and present, with the number of shares cancelled and issued. This book is also vital in computing documentary stamp tax, liabilities. A general knowledge of the names of large shareholders is also of value when checking the salary expense. When the stock and transfer book is not available, the record of dividend payment is an alternative source of similar information.

3. Partnership Agreement

A copy of the partnership agreement should be obtained and certain provisions affecting partner's salaries, profit and loss sharing, interest on capital, other allowances and other matters which may have tax consequences should be noted.

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4. Audit Report of Independent Auditors

The Revenue Officer should read the auditor's report accompanying the financial statements. Sometimes, Revenue Officers fail to evaluate the auditor's report. However, there are cases when auditors do not issue an unqualified opinion. Any qualification or unusual comments in the auditor's report or certificate such as expression of opinion as to taxpayer's depreciation policy, inventory and cost valuation, adequacy of reserves, status of collectibility of receivables and the like should be noted for consideration and should be related to the examination of accounts.

In cases where the auditor issues two reports, one for management and the other for attachment to the tax return, the former should be studied and compared with the latter. Income and net worth in both reports may vary from income and net worth per books due to the auditor's adjusting entries not reflected in the books. Thus, the adjusting entries and supporting documents should be examined. If needed, the auditor's working papers should be looked into to explain these entries.

5. Auditor's Working Papers

Audits, particularly of large companies, may frequently be simplified and facilitated, if the examining Revenue Officers are given access to the auditor's working papers. Where necessary, authorization from the taxpayer or requests for access to said working papers signed by duly authorized officials shall be secured to be able to scrutinize the working papers of auditors, particularly the year-end adjustments, intercompany transactions, nature of receivables and other peculiar accounts.

6. Statements and Schedules Filed with Government Regulatory Agencies

Certain taxpayers are required to file financial statements and other reports with government bodies such as the Securities and Exchange Commission for corporate taxpayers, the Garments and Textile Export Board for-garments exporters, the Board of Investments for exporters, and other similar government offices. The Revenue Officer should compare the statements filed with the Bureau of Internal Revenue against those filed with other government offices. Any discrepancy should be inquired into and material differences should undergo an in-depth investigation.

7. Appraisal Reports

Appraisal reports, particularly real estate appraisals, are important in many cases such as for estate tax valuation of properties, capital gains tax verification, and donor's tax investigation.

E. Initial Examination Techniques

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One technique that should be commonly used is for the Revenue Officer to interview the taxpayer or his representative and ask him to walk him through the book recording of a sale, purchase and expense transaction in order to have a thorough understanding of the taxpayer's accounting system and records.

2. Reconciliation of Books and Returns

Another step in understanding the records is to perform a reconciliation of the books with the return. The following actions are recommended to assist the Revenue Officer in the reconciliation process:

2.1 Request for a Chart of Accounts and identify account numbers and account titles.

2.2 Identify unusual accounts. AHaETS

2.3 Scan the general ledger to discover unusual account entries.

2.4 Ask the taxpayer for the ,tax working papers or any other type of working papers that were used to prepare the return.

If the working-papers are in the hands of the external auditor, the taxpayer should be advised to secure a copy thereof from their auditor.

If no working papers are available, request the taxpayer to prepare the reconciliation and supporting schedules used to arrive at the reconciliation of data as reflected in the books and the tax returns.

2.5 Evaluate the Statement of Changes in Financial Position, if the taxpayer has one, to identify sales and purchases of fixed assets, investments made and disposed, loan and debt payments, capital contributions and other transactions that might not be readily apparent on the balance sheet and income statement.

3. Performance of Compliance Tests

The Revenue Officer should establish the level of reliance that can be placed on the books and records and determine whether the books show all the transactions which occurred.

To accomplish this, a compliance test should be performed on some transactions through the backward and forward approaches in verification as follows:

3.1 In the backward approach, the figures per tax return are traced to the trial balance, then to the general ledger, the various journals, and ultimately to the source documents such as sales invoice or official receipts.

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3.2 In the forward approach, the Revenue Officer should select a supporting document, say a sales invoice, and trace it through the sales journal, general ledger, trial balance and finally to the tax return.

The backward approach is effective in checking unsupported expenses while the forward approach is used in uncovering unreported income.

4. Analysis of Adjusting Journal Entries

It is important that the Revenue Officer understands adjusting journal entries because tax issues are frequently discovered in the adjusting journal entries. These adjusting journal entries are usually accruals, deferrals, corrections or reclassifications of accounts.

4.1 Accruals are normally entries to record certain known and fixed amount of obligations or liabilities. Accruals are also used to book uncertain,. contingent liabilities. Contingent liabilities are not fixed in amount or date and are not deductible for tax purposes.

4.2 Deferrals are typically used to defer or postpone recognition of income or expenses. An inspection of the deferred income account may reflect amounts representing services already performed. It may also show goods already shipped and received by the customer. In both of these situations, a deferral of income is not proper.

4.3 Corrections of prior year's earnings, other adjustments and reclassifications are made through adjusting journal entries which are recorded in the general journal or in the journal vouchers. Usually, these entries are taken from the auditor's working papers. The examining Revenue Officer should scrutinize these entries, specially those credited directly to retained earnings, analyze the tax issues involved, and note down possible tax assessments.

4.4 When scanning adjusting journal entries, the following should also be looked into closely:

4.4.1 Unusual and non-recurring entries;

4.4.2 Entries reducing assets as there could possibly be unreported gain on sale, incorrectly computed gain on sale, incorrectly computed installment sale, non-taxable exchange, or withdrawal of goods by the owner; and

4.5 Entries increasing liabilities as these could represent fictitious or contingent liabilities, fictitious expenses, invalid loans to shareholders, or undeclared income credited to liability accounts.

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F. Evaluation of Internal Control

Internal Control is a system of procedures in place to ensure that all business transactions are properly recorded and assets are adequately safeguarded.

It is mandatory for the Revenue Officer to evaluate internal control for him to decide up to what extent the system can be relied upon. This will also determine the nature, extent and timing of audit tests to be applied in the examination and to plan subsequent audit procedures.

1. Principles of Internal Control

Good internal control assures good record keeping and the inability of the employees and the owner from misappropriating the assets.

Some broad principles of internal control are:

1.1 Responsibilities should be clearly established. 1.2 Adequate records should be maintained.

1.3 Assets should be insured and employees bonded. 1.4 Record keeping and custody should be separated.

1.5 Responsibility for related transactions should be divided. 1.6 Personnel should be rotated.

1.7 Automation should be used whenever practical.

1.8 Employees should be informed of prescribed procedures. 1.9 The system should be under constant review.

2. Elements of Internal Control

Internal control can be divided into three elements: 2.1 Control Environment

This includes the entity's organizational structure, methods of assigning authority and responsibility, engagement in related-party transactions and compliance with various laws, rules, and regulations. 2.2 Accounting System

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This consists of the methods and records established to capture financial transactions such as sales, purchases, investments and payment of expenses and liabilities. This element is important to the Revenue Officer for him to understand how transactions are initiated and recorded and to determine the degree of reliability to be placed in the taxpayers books and records.

2.3 Control Procedures

These include the adequate use of documents to ensure the proper recording, valuation and timing of transactions. Reconciliations of accounts should be done periodically and management should review reports for accuracy and completeness.

3. Standard Procedures in Evaluating Internal Control

To establish the scope of the audit and degree of compliance tests to be performed, internal control should first be valuated based on the following techniques:

3.1 Identify the personnel responsible for record keeping and determine their responsibilities and authority in the business operation.

3.2 Reconcile the returns with the books and records. Difficulty in reconciling the return with the books and records may be an indication of inadequate internal control in either financial or tax accounting.

3.3 Interview responsible company personnel and observe business operations. 3.4 Review the chart of accounts and identify unusual accounts or note those

accounts which should be included but not indicated.

3.5 Secure and study copies of operating manuals or instructional booklets that may lead to an easy understanding of the taxpayer's business operations. 3.6 Determine if the taxpayer's personal transactions are segregated from

business operations or if separate bank accounts are maintained by the owner and the business.

3.7 Determine if bank accounts are reconciled monthly.

3.8 Determine the books and records maintained and the frequency of recording transactions.

3.9 Determine if pre-numbered documents are being used.

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the business.

3.11 Determine if certified audits for any reason were conducted. If so, copies of documents in relation thereto should be secured. HIAESC

3.12 Determine if the income reported by the taxpayer reflects his lifestyle. The effective evaluation of internal control is dependent upon a very good interview, observation of the business operation, and testing of the system.

G. Sampling Techniques

Sampling is a large and important part of the examination of a tax return. It is the application of examination procedures to less than 100% of the items in an account to evaluate its accuracy.

1. Two Basic Types of Sampling 1.1 Statistical Sampling

Statistical sampling is the formal mathematical selection and examination of transactions, amounts or accounts based on the probability that moderately large number of items taken as samples will produce results from which conclusions may be made.

1.2 Judgmental Sampling

In selecting accounts and transactions to be tested, judgmental sampling should be applied as it involves the use of professional judgment in planning and performing the sampling and analyzing the results.

Judgmental sampling may include any or both of the following methods:

1.2.1 Block Sampling — uses groups of continuous items selected from an account balance or class of transactions. An example is a Revenue Officer's decision to sample one month of travel expense to reach a conclusion for the year.

1.2.2 Peso limitation sampling or cut-off sampling — selects a minimum peso amount and transactions in excess of the said amount are verified.

2. Factors to be Considered in Planning the Sample 2.1 Internal Control

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The extent of sampling to be done is dependent on the degree of internal control. Thus, a small sample size is required if internal control can be greatly relied upon.

2.2 Accounting System

Large errors or high frequency of errors in the accounting system may require a large sample size.

2.3 Materiality

In choosing appropriate material limits, the absolute size of an item, the relative size and the nature of the business, and industry/business practice should be considered. Materiality of an item should be related to its tax consequence.

2.4 Analytical Review

In analytical review, the following considerations should be studied:

a. Taxpayer's standard of living b. Interest in closely held companies c. Transactions between related parties d. Transaction involving questions of fraud

e. Significant increases or decreases in taxable income from year to year

f. Significant adjustments on previous Revenue Officer's reports 3. Sampling Techniques to be Applied in Testing Accounts and Transactions

There are many sampling techniques as there are cases. The Revenue Officer is not precluded from discovering and applying new techniques as may be needed in each particular case.

Listed below are the suggested sampling techniques in testing income statement and balance sheet items:

3.1 Select the first and last months of sales to ensure that income was not deferred to an improper year.

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of the likelihood of errors and unallowable adjustments made before the end of the year.

3.3 Selection of the largest three months incurrence of an expense account may reveal expenses that should be capitalized, personal expenses or padded expenses.

3.4 Scan the cash disbursements journal and general ledger for unusual or very large entries. This step also familiarizes the Revenue Officer with the accounts, payees, suppliers and clients of the taxpayer.

3.5 Select at least one month's (or one week for a large corporation) file of cancelled checks. Thoroughly analyze each check together with the endorsement at the back. This could lead to the discovery of fictitious; payees, unusual transactions, personal items charged to expense and other possible disallowances.

3.6 Inspection of the corporate minutes and the articles of incorporation could lead to a Revenue Officer's determination to sample a particular account. 3.7 Examine certain accounts in the income statement in relation to the

balance sheet accounts. Thus, Accounts Receivable should be analyzed together with Sales. Bad Debts Expense should be verified together with the Allowance for Bad Debts. Likewise, Accounts Payable should be examined together with Purchases and other related expenses.

3.8 Test-check source documents and related transactions by considering the persons involved, nature of the contract, mode of payment and other important aspects.

3.9 Rounded figures should be checked as they may be estimates. 3.10 Utilize results of analytical review in selecting the sample.

3.11 Contract or limit the scope of the sample if the majority of the samples are completed and there are still no discrepancies.

4. Examining the Sample Items

The sample items, as selected, should be verified as follows:

4.1. Analyze and determine the validity of the source documents. 4.2. Examine collaborating documents.

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4.4. Inspect and observe inventory flow, fixed assets acquired, sales transactions and other transactions which may require ocular inspection. 5. Analyzing the Results

Analyzing- the results of a sample is an important yet commonly missed step. The sample taken should be evaluated and considered in relation to any peculiar situation, such as related -party transactions or economically unsound transactions. One example would be purchases made at unusually high or low prices. If the results of the sampling indicates potential tax assessment, an in-depth analysis should be conducted as follows:

5.1. Verify the account showing the discrepancy or possible source of tax deficiency.

5.2. Trace the audit trail involving the transaction. 5.3. Perform a 100% verification of such account.

5.4. Consider performing third-party checks to substantiate transactions. 5.5. Take a close look at how the taxpayer handled the entire transaction. 5.6. Consider the adjustments associated to other accounts.

5.7. Discuss the problems or discrepancies with the taxpayer or his authorized representative.

6. Concluding the Sampling Results

The audit samples should be clearly documented in the working papers from which a conclusion shall be drawn. If a quality sample analysis has been performed, it will be easy to form a conclusion from the sample results. The conclusion reached should be clear, concise and final.

IX. Balance Sheet Approach To Examination

A series of suggestions on the procedures for commencing the examination of tax returns and appropriate accounting records have already been presented. The initial phase includes a verification of the net income per books with the reconciling items reflected in the tax return.

After the foregoing process, the Revenue Officer should turn his attention primarily to the books and records bearing in mind that there are some reconciling items which affect the net income per books.

Figure

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References

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