Over the course of 26+ years as a sales tax auditor with the California Board of Equalization, I saw a lot of interesting accounting methods and strategies. I thought I’d share a couple of the more creative ones with you.
When training new auditors, audits are conducted “by the book,” so certain steps are performed that a more seasoned auditor would generally skip. In one such audit of "In Sight" (see disclaimer below), a sporting goods store, a significant amount of resales were noted being made to “Outa Sight,” another sporting goods store. When questioned, the taxpayer informed us that the owner of Outa Sight was her sister.
Being a training audit, I instructed the trainee to check the BOE’s computer system and confirm Outa Sight was reporting a sales volume in keeping with the purchases from the first store. Strictly by the book. Imagine my surprise when the trainee found Outa Sight was reporting about half as many dollars in total sales as they were buying from In Sight. Since not many companies stay in business while buying twice as much inventory as they sell, we decided to audit Outa Sight.
The sales records provided by Outa Sight agreed with the sales tax returns they were filing. The purchase journal showed a volume of purchases in line with the recorded sales. In other words, about half the purchases from In Sight were not recorded on the books of Outa Sight. At this point we showed the owner copies of the invoices for all the extra goods from In Sight. The two sisters must have discussed the situation previously because the Outa Sight owner simply said, “I’ve got 2 other sets of books; which one do you want to see?” I asked, “Which of the three is correct?” The owner explained, “One is too high because I use it at the bank to get loans. One is too low, that’s the one you have now.”
We asked again, “Which one is correct?” Her response was the third one, so we went with the third set. Sales were scheduled from that third set and additional tax was assessed in the audit. When informed a fraud penalty would be imposed, her response was, “What do you want me to do, cry?” One tough lady.
Another case of “creative accounting” involved a retailer of kitchen appliances. Initially everything seemed to check out nicely - recorded and reported sales reconciled, tax collected equaled tax reported, overall markups were consistent and adequate. But while spot checking individual sales invoices, I noticed a large range of selling prices within the same models of refrigerator.
For example, most sales of a certain model would be for $2,000, but then there would be one for $1,000. Since this was before the wide spread use of computers, sales had to be scheduled by hand for the models in question. The analysis revealed a substantial number of sales over the three-year audit period with reduced sales prices. During the analysis, some sales of used refrigerators were also noted, which was odd since the retailer had no inventory of used appliances.
Copies of invoices for the new sales at low prices and of the sales of used refrigerators were made and a sample of the new refrigerator purchasers was contacted. All purchasers contacted stated they had traded in an appliance when they bought their new one, so I asked them to provide copies of their original sales invoices. Not surprisingly, their copies showed a sales price of $2,000 with a $1,000 credit for a trade-in and sales tax charged on the full $2,000 selling price. The taxpayer was pocketing the difference in tax on $2,000 and $1,000.
When presented with the documentation from the customers and the overall analysis, the taxpayer admitted to the scheme and volunteered it had been occurring for some period of time. In the end, fraud was assessed against the taxpayer and the audit period was extended back 8 years.
*Names are changed and certain details modified to protect the identity of real persons or businesses.
Other recent “Audits and Sales Tax” posts by Lloyd Geggatt:
- Software Audits for Buyers & Sellers – and the 3 Key Questions
- Luxury Audits: Empty Boxes Full of Champagne Wishes & Caviar Dreams
- Sales Tax Audits: Actual Basis Approach Can Result in "Win-Win".
- What Auditors Should Understand About Outsourced Sales Tax Returns
- Auditing Sales Tax Credits: An Auditor's Top 2 Considerations