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Industry Tax Audits: Finding the Beef in Planes, Trains & Automobiles

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All audits are not created equal. In past blogs, I went into some detail on audit procedure and approach for bars and restaurants. You may recall the audit focus in that industry is on establishing the mark-up factor and the adjusted cost of goods sold against which the mark-up is applied. But in other industries, mark-ups and cost of goods sold are of lesser or no value. Let’s take a quick overview of how audits work in manufacturing, defense contracting, construction and the auto industry….

Manufacturing

When auditing manufacturing companies the focus is generally on non-taxed sales and possibly purchases. Yes, total sales will be verified and mark-ups calculated to help confirm that those sales are consistent and adequate for the industry and specific business, but those are simply standard operating procedures (SOP). This is not where one would expect to find the meat in this type of audit. That will be in found in a detailed examination of exemption certificates and other supporting documentation behind the non-taxed sales. In many states it would also involve the examination of customer purchase orders (PO) because a PO can supersede an existing exemption certificate. Other state-specific potential focus points are such general ledger expense accounts as tooling, manufacturing aids, and supplies (looking for catalysts and other substances that do not become a component part of the product resold).

Defense Contracting

With United Sates defense contractors, the majority of the audit effort will be spent examining contracts mainly to determine if the contract is a commercial one or if it is with a United States government entity. Commercial contracts can generally be audited just like any other retail sale, but government contracts require a different approach. Some states have ruled that for sales tax purposes, everything the contractor purchases is considered to be resold to the US government prior to use, as long as certain title clauses are contained in the contract. And I mean everything―toilet paper, catered lunches, fertilizer for the landscaping, etc. The only exceptions are goods and services specifically disallowed by the government itself, such as penalties and booze. So auditors will spend their time in front of stacks of contracts looking at the “title pages” for the presence of the appropriate title clauses.

Construction

Audits of construction contractors, on the other hand, focus primarily on material purchases. This may seem like the same focus as with bars and liquor stores, where establishing the cost of goods sold is a key audit component. And in some ways it is how the cost is established and what is done with the information that differs greatly. One reason for this is that construction contractors can contract with their customers in different ways. The contract may be time and material, fixed price, cost plus some fee, or some combination of these. Another reason is contractors may buy materials on a job-by-job basis or they may simply maintain an inventory of stock from which they pull material as needed. Both these factors, along with others, impact how cost of goods sold is calculated. The process is much more difficult than simply counting all the cases of beer a liquor store purchased during the audit period.

Auto Industry

One final example of an industry with a different audit focus is the auto industry. In audits of both new and used car dealers, the main objective is to account for all the vehicles. This is rather obvious since the units sold are of relatively high value and there are relatively few of them. Some states make this a straightforward process by issuing Report of Sale (ROS) books to the dealerships. These are essentially coupon books where each coupon is pre-numbered. The books are issued in sequential order to the dealerships. Each time a vehicle is sold, the dealer completes one of the coupons with the required information, files one copy with the appropriate state agency and maintains a copy for their own records. An auditor need only obtain a list of the books issued to the dealership and then account for each coupon. It’s a bit more complicated than that, but that’s the basic focus.

So as you can see, if an auditor has any hope of gaining experience across a multitude of industries he or she can’t be a one-trick pony. He needs to identify “where’s the beef” in each industry and learn the appropriate audit techniques for that industry. Otherwise, that audit career could be spent sitting on empty cases in the backrooms of bars and liquor stores.

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