Board of Equalization Audits - Short Tests and Sampling – Part Two

In general, when auditing a business with good internal control, and a good accounting system, the test period may be a relatively small portion of the total audit period. However, in an audit of a business with little or no internal control, the test period most likely will cover a larger proportion of the audit period. If records are available, the periods selected for test will be spread over the entire audit period so that samples can be taken of all years and all seasons of the year. The size of each test period, in addition to the above considerations, will depend on the number of documents required to be examined. Usually the test periods consist of complete months or quarters, but periods of less than a month may be selected by auditor if daily or weekly controls can be established.

BOE statisticians have established that several short tests over the audit period are superior to one equivalent long period. For example, a test of three scattered months throughout the audit period will give better results than a one-quarter test. BOE checks for errors and statistically applies them to general number of transactions. If errors are irregular and non-recurring, BOE will eliminate them from the test and be excluded from the calculations of a percentage of error. For example, any sale that is rare, out-of-the-ordinary, can be considered, for classification, as nonrecurring.

An audit made on a test basis where there is no supporting detail (i.e. — no detailed journals) is conducted similarly to a detailed audit where there is no support for the claimed amount. However, the taxpayer will be requested to prepare supporting schedules for the test periods only.

The proposed measure resulting from the projection of the sample results will be compared and analyzed for reasonableness by looking at the taxpayer’s business as a whole. If the results appear unreasonable, the auditor will discuss the situation with the taxpayer. The auditor and the taxpayer will need to come to some kind of agreement as to whether or not the results are representative of the business for the time period in question. The auditor will, whenever possible, discuss the use of test periods with the taxpayer, include the taxpayer in the development or selection of a sampling plan, and endeavor to obtain a concurrence. In fact, very often during audit auditor will discuss and consult with business taxpayer audit, its procedures and techniques, to ascertain necessary information for audit. If, during the course of a sample, a document cannot be located, normal auditing procedure requires the auditor to ascertain the reason for the missing or incomplete documents. When the investigation fails to reveal any specific reason, the auditor may first determine whether there is any acceptable alternative evidence. Auditor and taxpayer will work together to obtain missing documents or auditor can ask for additional documents that may indirectly provide information sought by auditor.

The auditor will develop sampling plan to outline methods of testing, time frame and so on. Prior to determining the type of testing to be used in a given audit situation, the auditor must make a thorough examination of the business operation for the period under audit. This examination includes a review of source documents, changes in business activity, and changes in accounting procedures and key personnel. Plan is usually completed with assistance and input from the taxpayer. The information and methods documented in this plan are not binding on either the taxpayer or BOE staff. The sampling plan can and will be continually evaluated (and changed, if necessary) based upon information obtained during the audit process. However, if any deviation from this sampling plan is required, the deviations are fully explained and discussed with the taxpayer.

Board staff must first try to obtain from the taxpayer any data or documents which should have been retained in accordance with Revenue and Taxation Code section 7053. However, if all other available avenues of information have been exhausted and approval of the district administrator has been obtained, BOE staff may request the information directly from the taxpayer’s financial institution either by obtaining the taxpayer’s authorization or by issuing a subpoena duces tecum. Procedures for requesting records directly from a financial institution must comply with the California Right to Financial Privacy Act.