9-5 Accounting Answers
Basemat Doolen
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For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
A: Electronic information management has become the standard in the private sector and is now being used to enhance the IRS examination process. Obtaining accounting records in electronic format provides significant advantages:
A: The IRS will request electronic accounting software backup files using Form 4564, Information Document Request (IDR), early in the examination. IRS will also request the administrator's username and password, as they are needed to read most data files.
A: The taxpayer can preserve any favorite password by changing the administrator's password to a temporary one, such as "IRS Audit." Create the backup file for submission and then change the password back to the original "favorite" one within the main accounting software working file.
The temporary password must have administrator access to the backup file provided because the IRS needs to have the same access levels as the administrator. If the examiner does not have the administrative password, he or she will not be able to read the data as needed for the examination.
A: At this time, IRS has the ability to accept and read data files from accounting software programs that are used by most business taxpayers. Taxpayers should consult with the examiner before submitting any type of electronic files.
Whenever possible, the IRS will work with the taxpayer and their electronic accounting records to reduce the number of information document requests (IDRs). However, if the examiner is unable to read the electronic accounting records, he or she will determine the best course of action to complete the audit in a timely, efficient manner.
A: Using electronic records to conduct examinations should make the audit more efficient for everyone. Examiners will be requesting these files in the majority of cases where the taxpayer already uses electronic accounting software to maintain their books and records. However, if the audit is limited in scope, such as auditing one specific expense item, the examiner may determine that requesting the electronic accounting software file may not be necessary. In broader scope audits, such as when verifying gross income, the backup file will likely be requested by the examiner.
A: Most accounting software programs can generate a large number of pre-set reports. Each report can be modified to fit the examiner's needs. When working with these reports, the examiner can "drill down" to the underlying data and documents to further investigate items, as appropriate.
The software also allows the examiner to test the integrity and veracity of the accounting records in making a determination as to the reliability of the records for examination purposes. However, the examiner may still need to request other documents when such records are necessary to properly test a return item or issue.
Note that, although Revenue Procedure 98-25 exempts certain taxpayers from the requirements of the Revenue Procedure, this does not create an exemption for any taxpayer from having to produce electronic books and records if they otherwise exist when a business chooses to use an electronic accounting software program to maintain their books and records.
Under Internal Revenue Code section 6001 and Regulation 1.6001-1, taxpayers are responsible for maintaining sufficient books and records to support the income and deductions claimed on their tax returns and for presenting this information to the IRS when requested to do so in an examination.
If a taxpayer declines to submit the requested materials voluntarily, the IRS has the right to summons the information requested, use indirect methods to reconstruct income and/or disallow the items reported for lack of substantiation.
A: If the taxpayer's representative chooses to decline to voluntarily submit the requested materials, the IRS has the right to summons the information and the representative could be in violation of Treasury Department Circular No. 230 PDF.
Subpart B, section 10.20(a)(1), of the Treasury Department Circular No. 230 PDF regulations states that "[a] practitioner must, on a proper and lawful request by a duly authorized officer or employee of the Internal Revenue Service, promptly submit records or information in any matter before the Internal Revenue Service unless the practitioner believes in good faith and on reasonable grounds that the records or information are privileged."
A: If the taxpayer or representative creates or reconstructs a new company file, for example, by re-inputting the transactions for only the year under examination, this new file does not satisfy the requirements or needs of the Internal Revenue Service. The new or modified company file is not a copy of the books and records of original entry. The altered electronic file would not meet the requirements of the Information Document Request or a summons and the taxpayer's representative could be in violation of Treasury Department Circular No. 230 PDF.
A: The backup file is an exact copy of the original books of entry and allows the IRS to review and test the integrity of the original electronic records using the software program. This testing cannot adequately be performed on records that have already been converted into Excel spreadsheets. Examiners are required under IRM 4.10.3.5, Evaluating the Taxpayer's Internal Controls, and the related subsections, to acquire an understanding of the accounting system for all types of business returns. An integral part of this process is an evaluation of the taxpayer's internal controls. Examiners use the information obtained during this process to determine the appropriate audit techniques to be used during the examination process.
Through tests and analysis of the electronic records in their original format examiners can properly evaluate the accounting system (including internal controls) to consider the reliability of the books and records. This process is not unique to examinations where the electronic accounting records have been requested. Chief Counsel Advice No. 201146017 PDF.
A: If IRS is given a backup file that includes data for years not under examination, IRS will not utilize that data during the examination of the current year. If based on the results from the current year examination a decision is made to expand the scope of the examination to prior or subsequent years, the taxpayer will be notified. The records may be utilized after that notification.
However, the examiner may review transactions that occurred in the month prior to and the month after the tax year or the tax periods before and after the ones under examination if the transactions in those timeframes are relevant to the examination. Examiners may also review any transactional data created or changed during the tax year under examination.
For example, if a business under examination uses the accrual accounting basis, then it will be relevant for the IRS to examine transactions for the month prior to and the month after the tax years under examination to test the cut-off of reported income and expenses. The same is true if a taxpayer creates a transaction to record sales during the year under examination, but the actual transaction is dated in a prior or subsequent year, then the examiner can inquire as to why the taxpayer determined the transaction would not properly be recorded in the year under examination.
As another example, if the IRS was exploring whether to reconstruct income by an indirect method (e.g., bank deposits or net worth method), then certain information for the tax periods immediately preceding and following the year under audit would clearly be relevant. An inspection of the tax returns which are prior or subsequent to the tax years under audit does not constitute an examination of books and records. Examiners are expected to inspect such tax returns in all examinations, and to compare them to the tax returns that are under examination.
A: IRS examiners may request the electronic accounting software data backup file to include the month prior to and the month after the tax year under examination, thus a fourteen (14) month period.
An examiner who makes this request is often looking for data for the month prior to and the month after the year under examination, in order to ensure a proper cut-off of reported income and expenses for the year under examination. Sometimes the examiner may need to look at other categories of data pertaining to the month prior to and the month after the tax year under the examination, in order to conduct a proper examination of the tax year.
If the fourteen month period is insufficient to establish an accurate cut-off of revenue and expenses, or to verify other items, for the year under examination, the examiner may request a broader period. The IRS must only show that the information requested is potentially relevant to the issues related to the year under examination in order to request the information.
A: Many accounting software programs will condense old, closed transactions occurring prior to a manually selected date. For example, the closing of a prior year. Often this is done to reduce the size of the company data file. The process essentially removes the details of those transactions from the data file and replaces them with summary journal entries, allowing monthly financial statements to be created for old years if needed.
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