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

the agent has made the correct analysis, but applied it to an incorrect account. Unless the
designated representative is forthright regarding his or her knowledge of these accounts, the
adjustment will disappear. A little time spent up front will save time and perhaps embarrassment
later. Frequently, adjustments to balance sheet accounts result in an increase to taxable income.
Remember that all income statement accounts are run through the balance sheet, but not all
balance sheet accounts are run through the income statement. An example of entries in balance
sheet accounts not affecting the income statement could be a loan to the shareholder eliminated
through retained earnings. The entry involving a corporation is:
Debit Retained Earnings
Credit Loan to Shareholder
According to this entry: Retained Earnings is an Equity account and loans to shareholder is an
Asset account. If the loan to shareholder account is an asset and it is being increased as a result
of a loan being made to shareholder, the account should be debited rather than credited to reflect
an increase in the account’s balance. The cash account should be credited to reflect the decrease
or payment of cash in that situation. If an examiner observes the above entry, they should be
advised that further inquiry is necessary.
The manufacturer’s statement should be secured in order to establish confidence in the taxpayer’s
balance sheet accounts.
Schedules M-1 and M-2 have definite balance sheet implications and should be reconciled and
looked to for help in identifying what the taxpayer is doing. Differences between book and tax
treatment of items should be questioned and taxpayers should be asked to submit their authority
for any differences that do not appear to be compatible with generally accepted accounting or tax
principles. This is also a place where deviations from reliable manufacturer statements may occur.
Please see the appendix section of this Guide for a compendium of audit techniques relative to
specific balance sheet accounts utilized in the auto dealership context.
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