The IRS has provided QuickBooks accounting software training to its Small Business/Self-Employed (SB/SE) division examiners. While the training was limited to that particular software, practitioners should expect that information requested for small business audits will change for all taxpayers using an accounting software package. It is always helpful for practitioners to understand how the other side thinks, so a review of the new IRS inquiries regarding software and transaction printouts will aid CPAs in representations before local SB/SE examiners.
The IRS small business examiner is required to review a business’s system of internal control to enable the examiner to better plan the audit. The auditor is trained to review the accounting software’s built-in controls and how taxpayer use of those controls could affect the IRS’s reliance on the accounting records. The IRS will likely ask questions about who makes deposits, who performs the bank reconciliation, and who enters sales information into QuickBooks. A good source for likely IRS interview questions can be found on the IRS website in the Cash Audit Techniques Guide.
Practitioners should expect IRS questions about who can access the accounting software and whether login passwords are assigned to specific users. The purpose of the questions is to identify which persons have the ability to change accounting entries. The audit trail feature in later versions of QuickBooks is not optional, and the examiner may request reports detailing changes of accounting records. The audit trail will identify changes in the original record, the date the changes were made, and the login identity of the person who initiated the changes. QuickBooks will also generate a voided and deleted items report that the examiner may request.
Reconciling Taxpayer Books to the Return
The first step in each of the IRS audit programs is to reconcile the amount on the return with the taxpayer’s records. The auditor will use this step to point out possible differences that may require additional analysis of taxpayer records. The IRS will ask about methods of accounting to determine if the books agree with the elected method on the return. QuickBooks company preferences can be set up for either accrual or cash books, and many QuickBooks reports can be formatted under either method.
Selecting Samples for Testing
The examiner is given classified issues to investigate in the audit. He or she will request a general ledger account of specific accounts to select for further investigation. The practitioner will have a better idea of the number of transaction entries in the account and may feel it prudent to suggest that the auditor specify a maximum number of pages to be printed. The auditor will likely be satisfied with a transaction report for selected months as a source for selecting a sample. It may be that the auditor will select reports of check details by vendor.
New Emphasis on the Balance Sheet
Practitioners have been used to auditors limiting their review of the accounting records to income and expense items reported on the return. The auditor may ask new questions about balance sheet transactions, such as a request for the computer-generated trial balance or a chart of accounts. The IRS will look for entries to the undeposited funds accounts or negative balances in accounts receivable. A printout of adjusting entries for retained earnings may be requested. Auditors will be instructed to review stockholder loan account entries and owner equity accounts for a sole proprietor.
Costly Representation Fees
The IRS audit programs for required inquiries may need a response from the practitioner beyond the materiality of the expenditure, so the inquiries may lead to much higher CPA fees to represent the taxpayer. Hopefully examiners will learn to pull back on required responses when the taxpayer is properly reporting income and expense on the originally filed return.
Required Taxpayer Responses
The taxpayer is required to substantiate deductions taken on the return, but the IRS is not allowed to go on fishing expeditions. Practitioners should comply with requested software printouts and should resist a request for a backup copy of the software. The IRS does not need the 15 years of data included in the company files or proprietary client lists to substantiate items reported on the return. It would be prudent for the taxpayer to want to control dissemination of the disk and the security of its passwords.
IRS training on computer bookkeeping systems has changed the climate of the small business examination. Practitioners should make sure that their own level of training is up to date in using the most common accounting software packages. If CPAs want to represent their clients effectively, their own software training should be upgraded to equal that of the IRS examiner.
John Miller is a faculty instructor at Metropolitan Community College in Omaha, NE. Kristine Wolbach is with McDirmid Mikkelsen & Secrest, P.S., in Spokane, WA, and is a member of the AICPA’s IRS Practice and Procedures Committee. For further information about this column, contact Mr. Miller at email@example.com.