Your company has been chosen…
You will receive a phone call or letter announcing the audit and, generally, the period being audited and which books and records to have available (you may be asked for more later on). Check the period being audited against your state’s statute of limitations on how far back an audit can go. Before your company chooses an audit date, make sure a knowledgeable accounting professional can be present to explain exactly how the returns were prepared and the source of reported amounts. Most state agencies prefer to conduct the audit at your office so they can see company operations firsthand. If an outside CPA prepared the sales tax returns being audited, arrange to have the audit at the CPA’s office at the same time that you choose the audit date. After choosing the date and place, ask for a letter verifying both. Request that you be called if anything is changed.
What on earth do they want that for?
Most firms are shocked at the number of books, records and documents requested in an audit. Excluding variations by tax jurisdiction, the most commonly required items are:
• All the books, including ledgers, journals (especially the sales journal) and pertinent schedules. These are used to determine total sales and how the business works.
• Prior year income tax returns—federal and/or state. The auditor compares sales reported on the income tax returns with sales reported on the sales tax returns. Your company may not want to share its income tax returns with outsiders, but these can save a lot of time verifying reported data.
• Original documents that support amounts on the books for the audit. These include: sales invoices and/or contracts; customer purchase orders; vendor invoices; purchase requisitions and/or orders; and any other items used to compile amounts. If any of these records are hard to produce—e.g., lost, destroyed or stored off-site—you must tell the auditor when first contacted. Auditors usually try to work with a firm to the extent the law allows. If other items are requested, ask why they are needed and how they relate to a particular tax problem. Most auditors willingly explain. Although not all items will be reviewed, have them available. Purchase data are usually needed for use taxes (these discourage customers from buying out of state to avoid sales tax), which most states have.
Sales claimed exempt as resales
Most states require documents to support sales claimed exempt as resales, such as a resale card or exemption certificate from the customer. Find out which documents your particular state requires, and have them ready. The auditor will probably sample these documents with block tests (selected quarters, weeks, days, etc.), statistical sampling or spot tests of items throughout the audit period.
Even one missing document can multiply your firm’s liability if an auditor projects it into a percentage. Example: Sales Company A has 100 exempt sales in the audit period and has documents for all but one. A random sample of 10 exempt sales picks up the one missing certificate. The auditor projects this sample to 10% of exempt sales are undocumented and therefore disallowed. Result: Sales Company A’s tax liability (plus interest and penalties) is many times higher than its actual liability.
1 American Institute of Professional Bookkeepers (AIPB