Auditing SMEs by gyvwpsjkko

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									                              Organisation for Economic Co-operation and Development




AUDITING SMALL AND MEDIUM SIZED
ENTERPRISES


10.General Principles of Audit /
  Audit theory


                       Ghana, 4 – 8 October 2010




                                                Centre for Tax Policy and Administration
    Strengthening Tax Audit Capabilities
     General Principles and Approaches

    The audit programme of a Tax Administration performs a
    number of important roles:

   Promote voluntary compliance
   Detect non-compliance at individual taxpayer level
   Gather information on the “health” of the tax system
    (including patterns of taxpayers’ compliance behaviour)
   Gather intelligence
   Educate taxpayers
   Identify areas of the law that require clarification




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       Key principles audit programmes

   There should be a comprehensive documented set of audit
    policies and procedures that is readily accessible to all audit
    staff
   Audit policies and procedures should be based on principles
    of accuracy, efficiency, fairness, objectivity, transparency,
    completeness, consistency, and defensibility
   Revenue bodies require a systematic approach to the planning
    of individual audits
   Necessary support tools include industry benchmark data,
    business specific guidance materials, IT facilities, and the use
    of indirect income measurement techniques




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             TYPES OF AUDITS
                 which type to choose?


   FULL AUDIT

   PARTIAL AUDIT

   OBSERVATION ON SITE

   INVESTIGATIONS ( VALUE OF SHARES,
    PROPERTY, CASE OF BANKRUPTCY, ETC. )

   VISITS TO START-UP COMPANIES

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    Addressing Areas of Non-Compliance

    Tax Administrations have a number of ways to
    address non-compliance:

   Centralized task group developing risk detection
    and risk covering analysis
   Project management
   Automated audit programs
   Nationwide publications
   Training for auditors
   Reporting system


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                 Project management I


   To fight high impact risks
   Clear description of goals and mandate
   National, regional, local basis
   Potential focus areas:
        - A type of business (hairdressers)
        - A complete supply chain ( from farmer to
    product
           in the supermarket
        - Economic risk ( travel expenses )
        - Particular fiscal risks ( incentives, tax
    havens )
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                 Project management II



   Feasibility study, preliminary investigation,
    execution, evaluation
   Centralized project team and management
   High level steering group for decision making
   Communication with tax authority at the highest
    level and politicians
   Standard scenarios, plans of action, software
   Progress control, reporting and evaluation




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                  Project management III

                      good practices

   Cooperation with other government organisations
     ( police, social insurance )
   Getting the right people in the right place is critical
   As is the choice for the project manager
   Short communication lines to policy makers
   Discuss the project with all operational staff
    involved
   Periodic briefing meetings
   To be flexible if necessary


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          Human resources for projects

   Well prepared plans are successful if the people
    involved possess the right knowledge, skills and
    attitudes for the particular actions

   Required skills and attitudes:
    - experience
    - creativity
    - enthusiasm to be involved in the
       particular action
    - good communication skills
    - ability to deal with non-compliant, if
       not criminal, taxpayers
    - knowledge of legislation, policies
       and procedures




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                 The supply chain I

    Once of the record money has been created it
     makes it possible to create more of the record
     money
    Within the same supply chain or another
    For example: a constructor sells rubble, receives
     cash. He hires employees at a sub-contractor and
     pays for it with that cash money. The sub-
     contractor will buy goods and hire employees with
     that same cash plus a mark up.
    Do not accept a delivery without an invoice or
     anonymous deliveries as it contains vital
     information for tax auditing purposes

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                    The supply chain II

    Penalties on non-invoice or anonymous deliveries should be
     high enough to discourage potential fraud

     Targeted audits on the invoice obligation within a chain –
      especially at the beginning of the chain – are extremely useful
      for this purpose:
     - to help taxpayers to become compliant
     - to gather information for other audits in the chain

    These audits might be aimed at the administrative
     organisation of a taxpayer maybe in combination with random
     sampling and observations on site


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          Different approaches to audits


        The synthetical approach
         (also: progressive
         procedure)
        The analytical approach
         (also: retrogressive
         procedure)
        The data-oriented           The tools and means are
         approach and,               called ”audit techniques”
        The organisation-oriented
         approach




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                  The synthetical approach


     Opening company balance sheet          Final company balance sheet and
                                                  profit and loss account

     Audit of the entries in the accounts
                 and journals
                                            Audit reconciliation of the fiscal and
                                              the company balance sheets
          Journal / general ledger /
                trial balance


     Audit of preceding journal entries                  Tax return



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                 The analytical approach


               Tax return                 Audit of preceding journal entries


                                               Journal / general ledger /
                                                     trial balance
 Audit reconciliation of the fiscal and
   the company balance sheets             Audit of the entries in the accounts
                                                      and journals


     Final company balace sheet and
          profit and loss account         Opening company balance sheet



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     Synthetic versus analytical approach

    For the application of both approaches the auditor
     must know how reliable the internal entries and the
     external documents relevant to the investigation
     are. To what extent it is possible to form a
     judgement on the reliability (and the completeness!)
     of these documents depends largely on the
     effectiveness of the internal control system.
    The synthetical approach starts with the details,
     but this does not imply that every detail must be
     checked.


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       Organisation-orientated approach

    Check structure, implementation and functioning of
     the accounting system and the measures for
     internal control – survey and validity control
    Is the internal control system (sufficiently)
     effective?
    Is this audit approach effective?
    Efficient, requires less time than data-orientated
     procedures




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             Survey of internal control

     Standard questionnaires
        Allotment of responsibility and work – key
         persons powers
        Allocation and separation of duties
        Unauthorized availability of registers and
         programs
        Delivery notes/work orders?
        Cash register?
        Self-regulation in form of current
         reconciliations, counter checks, stock-takings
         etc.

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        Method of payments?
             Objective information

  Nature of business – understanding the business
 a. To know how to run a business is to understand
    how to audit a business
 b. Examples: farming, mining, wholesale, retail, mass
    production, unit production, services etc.
  Industry information (source can be previous
    audits or information from the industry or business
    itself)
  Equal treatment of all taxpayers in the same line
    of business


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            Third party information

 Types of third parties
  Third party investigation for a specific taxpayer
   (for example with suppliers or customers)
  Third party investigation for a particular industry
  Request for information from banks or other
   financial institutions
  Request for information from other authorities
  Information from Tax Authorities in other countries
  Informants (known and anonymous)

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         Correctness and Completeness


  Correctness checks – checking whether what
     has been reported and accounted for should
     indeed be reported and accounted for. It deals
     with correctness. ”Is what I see what I would expect to
     see?”
  Completeness checks – check whether all that
     should be reported and accounted for has
     indeed been reported and accounted for. It is
     directed at completeness. ”Can I see what I would
     expect to see?”



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          General interest of taxpayers

    Assets are more likely to be undervalued than
     overvalued. The aim of the audit will be completeness;
    Liabilities are more likely to be overvalued than
     undervalued. The aim of the audit is then correctness;
    Revenue reported in the profit and loss account is more
     likely to be too little than too much. The aim of the audit
     is completeness;
    Costs reported in the profit and loss account are more
     likely to be too high than too low. The aim of the audit
     is correctness.



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     Perfect Audits versus Imperfect audits


         Every audit must be “perfect”, i.e. it must form a
          composite whole, effective for the accomplishment of the
          function and consequently for the objective set; but it does
          not therefore need to cover all events, all facts, all entries,
          all data, it does not need to be “complete”.
                                       Furthermore the right tools and
          techniques must be used.       If not the audit is imperfect.

         Special investigations (or aspect inquiries) have
          limited objectives compared with the general
          audit
           These limitations does not and may not lead to an
          “imperfect audit”. On the contrary; through these
          limitations the audit focuses on special elements. The
          result of the limitations is an “incomplete audit” but it
22        remains a self contained whole, a “perfect audit”
            Direct and indirect methods
          to establish the taxable income

    The direct method: the total of all direct information
         - wages/salary
         - interests
         - rents from immovable property
         - sales of shares
         - deductible expenses
         - profits and losses

    As this information is delivered by the tax payer or reliable
     third parties it will be used as correct information, there is a
     burden on the Tax Administration to proof incorrectness
    Regarding expenses: the onus of proving that these are
     correct lies with the taxpayer



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     Indirect income measurement methods

    For many taxpayers there is a considerable risk that some
     income will not be reported by them in their returns in order
     to minimise their taxable income.
    Especially where it is easy to conceal income, as the income
     is not subject to any systematic third party reporting to the
     revenue body and/or it is difficult for auditors to otherwise
     directly verify such income with third party sources
    There is also a risk that expenses against business income
     may be overstated by taxpayers
    There is also a risk of poor quality, or non-existent, books
     and records




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                  Indirect methods

    All these methods are used to establish the taxable
     income from secondary or linked information

    Often used by the Tax administration, so burden of
     proof on them

    The use of estimates may make it necessary to use
     different methods in the same audit




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       Formal indirect methods used by
      revenue bodies to varying degrees

    Source and application of funds method
      (comparison of expenditures and receipts for the period; the
     excess of expenditures over the sum of reported and non
     taxable income is unreported taxable income)
    Bank deposits and cash expenditure methods
      (computing income by showing what happened to a
     taxpayer’s funds based on the idea that what a taxpayer
     receives can either be deposited or it can be spent)
    Mark-up method
      (reconstruction of income based on the use of percentages or
     ratios considered typical for the business under examination)



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       Formal indirect methods used by
     revenue bodies to varying degrees(2)

    Unit and volume method
      (gross receipts determined or verified by applying
     the sales price to the volume of business done by
     the taxpayer; volume might be determined from
     taxpayers cost of goods sold or expenses)
    Net worth method
      (increases in a taxpayer’s net worth during a
     taxable year, adjusted for non deductible
     expenditures and non taxable income, indicate
     taxable income)


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     When to use a formal indirect method

        A taxpayer’s known business and personal expenses
         exceed the reported income per the return and non-
         taxable sources of funds have not been identified to
         explain the difference
        Irregularities in a taxpayer’s books and weaknesses in
         internal control
        Gross profit percentages differ significantly from year to
         year or are unusually high or low for that market
        Bank accounts show unexplained items of deposit
        A taxpayer does not make regular deposits of income, but
         uses cash instead
        A significant increase in taxpayer’s net worth not
         supported by reported income
        No book and records available

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     Enforcement communication targeted on
                  consumers

     Consumers also play a role in cash economy
     Explain to consumers the risks of cash deals hiring
      contractors who don’t issue receipts and don’t
      prepare contracts (accidents, mistakes, losing
      advance payments, poor quality or incomplete work
      and no assurance)
     Explain to consumers that if they participate in the
      underground economy , they affect the
      governments ability to provide services such as
      education, health care, pensions and infrastructure


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     Auditing Small and Medium Size
               Enterprises




              12. The Audit Process




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                 Audit programme

     WHY?
      equal treatment of taxpayers
      similar work methods
      with an audit program as a base the auditor may
       form a specific program for the realization of an
       individual audit
      ensures that there are no issues that might be
       forgotten
      ensures that the work is done in a structured
       manner and that the audit is based on sound
       professional principles

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       Structure of the audit programme

    Examination

     Comprises
     • Supplementary collection of
       information
     • Analysis of collected
       information

     and leads to
     • A preliminary planning of
       the audit
     • A decision to make an audit

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         Example of an audit programme
                   structure

                            Examination
        Accuracy and flexibility
             “An examination carried out well increases
         the possibilities for a fast and effective audit”
        Gathering of available information within the
         authority
        Information from other authorities
        Should audits also be carried out at related
         companies?
        Specific actions? (search of the premises, distrait
         order for securing payment etc.)
        Planning for the basic control
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        Example of an audit programme
                  structure
                             (continued)

    Basic control

     Comprises
     • First contact with the tax payer
     • Preliminary discussions with the tax payer
     • Mapping of systems
     • General review
     and leads to
     • Identification of problem areas and risks
     • Establishing of the audit plan

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        Example of an audit programme
                  structure
                             (continued)

                       Basic controls
    First contact with the taxpayer
     • Information about the decision to audit (written and verbal)
     • Preliminary contact – how this is done depends on the
       individual audit and the stage that audit is at
     • Confirmation of the future actions
    Preliminary discussion with the taxpayer
     • Introduction of the business
     • Questions about the business
     • Accounting documents
     • Practical information

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         Example of an audit programme
                   structure
                                   (continued)


                         Basic control (continued)
        Mapping of systems
         •   General survey (available information, connection between
             accounting system and other systems, how to access the information)
         •   EDP auditing (more about that later)
         •   The reliability of the accounting system
         •   Internal controls

        General review
         •   General examination (minutes and records, information about the
             group and the organisation, contracts, personnel agreements etc.)
         • Examination of the financial statements and current recording
           of transactions
         • Examination of the VAT/GST accounting
         • Examination of the payroll accounting
         • Examination of the excise duties
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         Example of an audit programme
                   structure
                              (continued)

                    Essential controls
    Examination techniques (internal control, substantive
     testing, tests using random samples, partial examination)
    Key issues (lump sum or certain types of transactions)
    Risk assessment (complex transactions)
    (Change in the audit plan, might even include
     terminating the audit)
    Gathering and evaluation of information (information
     from; the accounting records, representatives of the
     company, other documents, third party)
    Particular examinations
    Reviews and evaluations


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         Example of an audit programme
                   structure
                              (continued)

    Completion

     Comprises
     • Review a summary of the proposed
       adjustments with the Taxpayer
     • Audit report and other written communication
     • Legal checking (a continuous process)
     • Documenting the records and other
       administrative accounts reviewed
     • Closing and filing


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        Example of an audit programme
                  structure
                        (continued)


                          Completion
    Review with the taxpayer (changes in taxation and
     continuation of the case)
    Documentation (correspondences, decisions, copies
     of documents, notes, computer print outs etc.)
    Registration (statistics, journals etc.)
    Filing (documents that must be retained, copies
     etc.)
    Confidentiality



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                      Negotiations

        Sometimes changes in taxation might be
         negotiated
        Who will negotiate?
        Negotiating is an art: consider video-training
         and assistance from experienced trainers

        Negotiating “normal” adjustments is not the
         same as it is in criminal cases (interrogation)
        Most countries have experts who deal with
         criminal cases, the auditor stops his audit and
         will hand it over, in the meantime:
        The taxpayer should be told that he has no
         obligation to answer

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              Negotiations continued
                         some issues



    Golden rule: be prepared
    List the issues you want to discuss
    Underline the issues that can be negotiated and
     those that can’t be (like the tax rate, interest and
     penalty)
    For every issue: state your max and min amount
     and the amount you like to come up with in the end
    Never bid under your min
    Imagine in advance what arguments the taxpayer
     will tell you to bring the adjustment down

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              Negotiations continued
                        some issues



    Prepare your answers to his arguments
    Consultations with a colleague might help you
    Be consistent, don’t contradict your colleague when
     you are both in the same discussion with the
     taxpayer
    Prepare negotiations together
    Listen carefully to what your taxpayer tells you
    Does he give any open or non-verbal signals to
     show that he is willing to move ( like: may be,
     sometimes, etc. )

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              Negotiations continued
                          some issues



    Never make two consecutive bids, let the taxpayer
     counter-bid
    Don’t go too fast, if your opponent is not
     answering: just wait, don’t be afraid of the silence:
     he will start talking
    Talk business, no subjective arguments
    Refer to the rules of negotiation if it gets
     unpleasant
    Restate the final agreement and make sure it is in
     writing


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