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Auditing & Statistical Sampling. Current & Best Practices. Michigan Department of Treasury Roslyn Branner Mary Ann Nye Stan Weber Ryan Joseph J. Tomczyk. Audit Goal. Determine the correct amount of tax No More No Less. Sampling Goal.

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auditing statistical sampling

Auditing & Statistical Sampling

Current & Best Practices

slide2
Michigan Department of Treasury
  • Roslyn Branner
  • Mary Ann Nye
  • Stan Weber

Ryan

  • Joseph J. Tomczyk
audit goal
Audit Goal

Determine the correct amount of tax

  • No More
  • No Less
sampling goal
Sampling Goal
  • Create a subset of the data population that mirrors the population activity
  • Acceptable to both parties
factors
Factors
  • Transactional Data Availability
  • Consistent Activity Throughout The Audit Period
  • Acquisitions / Dispositions
  • Records
    • Number
    • Complexity
    • Adequacy
    • Sufficiency
why sample
Why Sample?

Cost / Benefit

  • Divert Professional / Compliance Staff – How Long?
  • Engage Independent Consultant – How Extensively?
  • Provide On-Site Resources to Auditor – How Long?
considerations
Considerations
  • Audit Scope
  • Plan / Agreement
  • Data Validation
  • Sample Evaluation
  • Sample Projection
  • Post-Audit Use of Results
slide8
Communicate Before
  • Communicate During
  • Communicate After
auditing statistical sampling current best practices

Auditing & Statistical Sampling: Current & Best Practices

Michigan Department of Treasury

Tax Compliance Bureau - Audit

Presented by:

Roslyn Branner

why do we sample
Why Do We Sample?
  • Continuation of New Technologies
  • Become more efficient in our Audit Processes
  • A balance between accuracy and efficiency
  • Cost and effectiveness
  • Quality
statutory authority
Statutory Authority

To Sample:

  • None available at this time

To Audit:

  • Revenue Act – Provides the Authority to Audit
  • Taxpayer is required by law to maintain records for a four year statutory period.
  • Records stored by taxpayer are subject to review regardless of the manner in which they are maintained.
statutory authority1
Statutory Authority

Complete Records --Mich. Comp. Laws Ann. § 205.28(3) ; Mich. Admin. Code R205.4103

Conduct Examination -- Mich. Comp. Laws Ann. § 205.3(a) ; Mich. Admin. Code R205.4103 

Failure or refusal to file a return or pay the tax, or the Department's belief that a return does not give enough information to accurately determine tax due, triggers the Department's right to examine records, books, and so on, and to audit accounts so as to assess tax. [ Mich. Comp. Laws Ann. § 205.21 .]

statutory authority2
Statutory Authority

Subpoena Authority -- Mich. Comp. Laws Ann. § 205.3(a)

Multi-State Cooperation -- Mich. Comp. Laws Ann. § 205.28(1)(d)

records
Records

“Records” = Documents, books, electronic data, work papers, and/or any other information relevant to determine tax due, tax reported or tax collected.

current staffing structure
Current Staffing Structure
  • All auditors have been trained on statistical sampling procedures and how to use the software (ACL).
  • Each auditor performs all steps required to complete a statistical sampling audit.
  • Each audit goes through at least two levels of management review.
sampling methods
Sampling Methods
  • Non-Statistical Sampling
    • Manual
      • Block or Judgmental Sampling
      • Simple Random Sampling
  • Statistical Sampling
    • Electronic
      • Stratified Random Sampling
statistical sampling
Pros

Improves Accuracy

More Efficient

Virtually eliminates Taxpayer/Auditor Bias

Cost / Benefit

Performed in accordance with Generally Accepted Auditing Standards

Reduces data entry errors

Equal chance for all items

Improved Quality

Cons

Inherent Sampling Risk

Data for specified audit period is unavailable

Repeated request for data due to auditor / taxpayer miscommunication

Taxpayer or it’s IT Department is resistant to providing the requested data

Not an exact science

Statistical Sampling
sampling risk
Sampling Risk
  • Is assumed by all parties involved
  • Can occur when the sample does not reveal the true attributes of the population
  • The results of which can favor the Taxpayer or the Department or both.
  • Minimized with proper planning
  • Communication is a key factor
pre audit planning considerations
Pre-Audit Planning Considerations
  • Type of business
  • Multiple locations
  • Accounting Systems
  • Internal Controls
  • Decentralized or centralized accounting
  • Changes in business practices over time
  • Others
acceptable data file formats
Acceptable Data File Formats
  • Excel
  • Access database
  • Dbase
  • Delimited Text (Tab)
  • Print Image (Report)
  • Others – XML, ASCII, EBCDIC, etc.
media types to receive data
Media Types to Receive Data
  • CDs
  • DVDs
  • Flash Drives
  • External Hard Drive
  • Email (not encouraged by The Department)
handling of negative transactions
Handling of Negative Transactions
  • Ideally, all negatives would be matched with its corresponding positive transactions and removed from the sampling frame.
  • Remaining (I.e. unmatched) negatives are removed and given to taxpayer for review.
  • Remaining negatives will be used to offset any exceptions (I.e. errors) found in the sample.
handling of negative transactions1
Handling of Negative Transactions
  • Statistically, leaving the negatives in the sampling frame distorts the desired confidence and precision levels.
handling missing items
Handling Missing Items
  • Meaning:
    • A transaction where taxability can not be determined without reviewing the source document(s), however the source document(s) are unavailable and cannot be provided.
  • Are considered an exception (i.e. taxable)
  • Can not be replaced or substituted
handling duplicate transactions
Handling Duplicate Transactions
  • Should be identified and eliminated from the sampling frame prior to pulling the sample.
  • Similar characteristics within the data should be evident for the auditor to identify the duplicates if they’re unknown previously.
  • Control total verification may reveal duplicates.
extraordinary items
Extraordinary Items
  • Generally, no item is considered an extraordinary item.
    • All items represent the activity in the normal course of business
  • If Identified, can be pulled out of the population prior to drawing the sample
  • If not identified before the sample is drawn, will remain in the sample as all other items
factors in determining sample size
Factors in Determining Sample Size
  • ACL software
  • A customized module used in conjunction with ACL which automates the sampling process.
    • Sampling Criteria
      • Confidence Level
      • Relative Error Tolerated or Relative Precision
      • Minimal Sample items in each stratum
  • Samples can be reproduced without the module
factors in determining sample size1
Factors in Determining Sample Size
  • Optimal Strata Break Criteria
    • High Dollar Value
    • Low Dollar Value
    • Value of Pre-stratification Intervals
    • Number of Optimal Strata Breaks
    • Minimal Number of Items to be Selected
  • Cumulative Square Root of the Frequency
high dollar cut off
High Dollar Cut-off
  • Includes only the higher transaction amounts.
  • Detailed review only
  • Will not be projected to other years, when all data is available for the entire audit period.
  • Determined by auditor and agreed to by both auditor and taxpayer.
low dollar cut off
Low Dollar Cut-off
  • Referred to as the De-minimus area
  • Includes the lowest transaction amounts that are greater than zero.
  • Determined by auditor and agreed to by both auditor and taxpayer
  • Taxability is determined by projecting the adjacent stratum’s percentage of error.
low dollar cut off1
Low Dollar Cut-off
  • Purpose is to improve efficiency
    • Taxpayer does not spend valuable time pulling documents
    • Auditor does not spend time reviewing documents
  • Not to be assumed as an area that will be ignored.
  • Alternative methods
reviewing the sample
Reviewing the Sample
  • Review source documents to determine taxability.
  • Opportunity for the taxpayer to review and provide additional information not previously made available.
  • Opportunity for the taxpayer to review remaining negatives to off-set any determined exceptions.
projection method
Projection Method
  • Ratio Estimation
    • Basic Formula:

Sample Error in $s

------------------------- X Population Base in $s

Sample Base in $s

evaluation method
Evaluation Method
  • Performed by a Statistician
  • Performed on the largest statistical sampling audits
performing a sales tax audit
Performing a Sales Tax Audit
  • Detail review of transactions in an electronic environment
  • Statistical Sample
  • Non-Statistical Random Sample
  • Block Sample
performing a use tax audit
Performing a Use Tax Audit
  • Statistical Sample of Accounts of Interest
  • Non-Statistical Random Sample
  • Block Sample
  • Detail Review
the department s responsibility to the taxpayer
The Department’s Responsibility to the Taxpayer
  • Perform Statistical Sampling Audits in accordance with Departmental policies and procedures.
  • Maintain communication with the Taxpayer throughout the entire audit process.
  • Provided supportive documentation that clearly communicate the results.
  • Maintain complete confidentiality of taxpayer’s data and information.
the taxpayer s responsibility to the department
The Taxpayer’s Responsibility to the Department
  • Full cooperation from the taxpayer.
  • Provide records in a reasonable time frame.
  • Maintain records according to federal and state provisions.
  • Provide control totals
  • Provide a proper Audit Trail.
slide39
The previous content was intended for informational purposes only and is not to be interpreted as official statements of the Michigan Department of Treasury. The content, and/or statements made during the presentation, are not to be construed as promulgated rules, bulletins or rulings of the Department and are subject to revision pursuant to the effect of legislation, court decisions, regulations and official statements of the Department.
sample types
Sample Types
  • Statistical – use of statistical formulas
    • To determine sample size
    • To measure sampling risk
  • Non-Statistical – Can be anything else
    • Requires professional judgment
    • Generally, needs all parties consent
negative transactions
Negative Transactions
  • Generally increases the probability of selection.
  • Michigan’s uses a conventional approach, but not the only approach.
  • For example, Texas has a five step rule that they use to determine
    • If a negative transaction is going to be used in the sample.
    • How the negative transaction is going to be used in the sample.
  • Another approach is to treat all remaining negative transactions in a separate strata.
missing items
Missing Items
  • Michigan’s uses a conventional approach, but not the only approach.
  • Some states select replacement (additional) transactions at the time the sample is drawn to be reviewed if the source document for the original sample item is unavailable.
  • While the sample is drawn from a specific source document (such as an invoice), there is often alternative source information (such as a plant tour, discussion with plant manager, third party vendor, etc.) that can be a valid substitute in making a taxable / exempt decision.
other sampling considerations
Other Sampling Considerations
  • Stores
  • Utilities
  • Multiple populations / multiple samples
slide44
Communicate Before
  • Communicate During
  • Communicate After
summary
Summary
  • Michigan Department of Treasury has published its Audit Sampling Manual in March 2007
  • When looking at using a sample to conduct a Michigan Tax Audit
    • Look at the Taxpayer’s and the Department’s expectations.
    • Participate in the sample planning.
    • Understand how the results will be used to make audit determinations.
    • The sample and subsequent results are designed to reflect the Taxpayer’s activity.