Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

Chapter 5
Balance Sheet
Why do we care about a balance sheet audit? Balance Sheets are necessary where a corporation
or partnership is the business organization of choice. Most new vehicle auto dealerships are
corporations or partnerships.
As revenue agents we are concerned with doing balance sheet examinations in order to save time
and ensure we do a thorough job.
Entries made to many, if not most, balance sheet accounts have corresponding entries to the
income statement. Audit planning considering this duplication of entries will save an agent time,
eliminating potential duplication of effort. Consider this analysis, remembering that partnership
return balance sheets entries shown on Form 1065 are reported at Fair Market Value.
Balance sheet accounts are "real" accounts. These accounts represent things the dealership owns
or owes. Their balances are carried forward from year to year. This differs from income
statement accounts which are closed out at yearend and only reflect business operations within a
specified cycle. These operating accounts are closed to retained earnings and result in net income
or loss to the business.
Material fluctuations or changes to these real accounts may signify activities requiring
examination. These fluctuations and changes signify a change to things the dealership owns or
owes. These differences require effort on the part of the dealer when wealth is accumulated or
dispersed. If the wealth is not correctly accounted for in the books and records, this wealth may
be accumulated or disbursed without ever hitting income. As a general statement, such wealth is
taxable, unless a proper Schedule M-1 adjustment is made. The propriety of Schedule M-1
adjustments is addressed later.
The reason we do a 3 year comparative analysis at the beginning of an auto dealership
examination is to allow us to identify such changes and fluctuations that may require examination
in the audit planning stages. This analysis, coupled with financial status concerns, will aid in
determining the scope of the examination. Be aware that some dealerships may create multiple
entries which will not affect ending balances when netted together.
Tax classification of balance sheet accounts, performed when the books are reconciled to the
return, is paramount to a successful balance sheet audit. This classification gives us the ability to
spot curious relationships that may occur with these accounts. As an example, loans to
shareholders are often grouped in the other current liability account. If the balance sheet does not
specifically list this loan, its existence may never be discovered. This audit tool assists in the
determination of the examination scope.
The reconciliation also eliminates misfires. If an agent does not know which accounts comprise a
tax account, a proposed adjustment may disappear if the designated representative can
demonstrate the misclassification. Also, a viable adjustment may disappear in this context where
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