CoveR SToRy What's Looming On The horizon? - Ryan

cover story
What’s looming
on the horizon?
AR
audits
By Matthew R. Gomez
82 September-October 2010 AP Matters Today AR Matters

Audits are more than just a nuisance. They can be downright
scary. IRS and state regulatory agency audits can damage a company’s
reputation, create tension and suspicion within employee ranks, and tie
up essential company resources.
In some severe cases, when an audit hits pay dirt, the mistakes
may lead to significant penalties or even jail time for those
responsible for filing errors.
Concerned yet? You should be. With the ongoing global financial
crisis, some industry professionals forecast gloom and doom on
the audit horizon.
“The likelihood of facing an audit will increase in the near
future as governments batten down the hatches on instreams
of revenues from their side,” says Peter Lugli, senior director
of working capital management at Ariba, which provides
collaborative business commerce solutions. “Governments are
looking to increase tax streams in order to raise tax revenues.
Individuals and companies will be under increasingly greater
scrutiny. The trick is to prepare yourself and your organization
for the scrutiny that is coming your way.”
And the threat of punitive damages is real, says Lugli, who’s
based in Alpharetta, Ga. AR professionals in the United States
need only look “across the pond” to Europe for a glimpse of
what may be in store for individuals and companies staring
down the barrel of an audit.
“In Europe, where the value-added tax (VAT) regime is in place,
you effectively have to report and defend your back compliance
efforts,” Lugli says. “Depending on the jurisdiction, the
government agency can go back five to 10 years and make you
prove you were good on your payments. If you can’t prove that,
they can assess up to a 20 percent tax on your revenues. In
many cases, that could wipe out profits for the whole company.
This goes for large companies and mom-and-pop firms. It’s a
very real issue regardless of the size of the organization.”
No one wants to deal with the hassle and risk of an audit, so it’s
wise to take proactive steps to avoid even raising suspicions
with your records. But how do you prepare for the eventuality
that an audit will come your way?
Small errors lead to big problems
or confused data entry can be enough to raise a red flag among
auditors.
“When agencies audit, they audit the business as a whole, not
the AR individual who prepared the paperwork,” says Michael
Hsu, CEO and founder of Deep Sky Accounting in Irvine, Calif.
“This is especially true in a larger corporation. But if one of the
many hats of a small business owner also represents AR, that
is obviously a very different situation.”
Hsu’s company offers outsourced accounting services to small
businesses that are often overwhelmed, confused or apathetic
about accounting practices—until they receive notice of a
pending audit.
“I don’t think anyone cares about accounting, at least not in the
small business world,” Hsu says. “They want to create products
and services and go out and sell. But what you’re doing for
business accounting is not necessarily right for tax accounting.
You may recognize revenue in one year, but not be taxed on it
until the next year. How you recognize that revenue is essential
from an auditing perspective.”
Bill Norwalk, principal at Sensiba San Filippo in northern
California, says small errors can become big problems if they’re
not caught early in the process.
“The financial picture of the company may mislead
management—doubling the recording of sales, not recording
certain transactions, or not collecting monies when they are
due,” he says. “You really have to be careful with details and
not be content with just putting balances in the computer.”
Honesty is the best policy
Michael R. Bryant, CPA, who serves as chief financial officer
of the National Association of State Boards of Accountancy
(NASBA) in Nashville, Tenn., says AR professionals must
emphasize ethics if they hope to avoid feeling the pain of a
potential audit.
Accounts receivable professionals can sometimes get caught
in the crosshairs when it comes to potential audits. Any bit of
sloppy reporting, overlooked paperwork, mathematical errors,
“The risk with AR is that the receivables are overstated by the
organizations keeping the books,” Bryant says. “If they have
inflated AR, they are probably overstating their sales. An AR
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AR Matters
September-October 2010
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professional must act ethically. If you are acting unethically—
and that is a fine line, which includes ‘doing nothing’—then
these outside agencies that are protecting investors can come
after you.”
The temptation to inflate sales may be stronger than you think.
Relationships among AR, sales, and other departments within
the company sometimes lead to actions that stick out as a “red
flag” to auditors when the numbers don’t add up.
“You have to look at the incentives of those people around you,”
Bryant says. “Sales people have the incentive to sell as much
as they can. AR people may be put in a position to inflate sales
for short-term benefit.”
For example: If a commission-based salesperson issues a large
sale to a customer and passes it to accounting, the customer
may say, ‘Wait, I didn’t buy that much!’ Even if they get
pushback, which may take a few months, the salesperson will
have received his or her commission for that sale. By then the
salesperson may have cashed the check or left the company. The
company will have lost money because of this unethical behavior
and AR may be left to explain to the auditors what happened.
Bryant offers a basic rule of measure with regard to AR
and the fear of audits. “If others have lost money based on
your actions or inactions, you may be held accountable,” he
says. “To manage that appropriately, look at the incentives of
the people around you. Then, do what is right. Honesty is the
best policy.”
Can technology help?
Douglas J. DeRito, principal at Ryan Inc. in Atlanta, Ga.,
encourages AR professionals to properly use technology and
focus on optimizing business processes as a key to avoiding
audits.
“Business processes are often not set up for relevant data
management,” DeRito says. “Proper exemptions are not
claimed and managed from a data standpoint. If that persists,
errors occur and it could wipe out a company’s profit margin.”
DeRito suggests that closer attention be paid to the data
processes—including new enterprise resource planning or ERP
environments—in order to reconcile data and ensure consistent
and accurate information from all divisions. Failing to do so puts
a target on your back that auditors will easily find.
“Multiple legacy systems in different corporate divisions and
affiliated subsidiaries affect inter-company transfers,” he
says. “The process must be streamlined to avoid inputting data
two or three times, possibly paying bills twice or improperly
applying taxes where appropriate.”
DeRito and his colleagues perform assessments to determine
the best solutions for their clients, and warn companies about
making large ERP purchases, such as SAP or PeopleSoft,
without first doing due diligence.
“I see all of these companies making huge technology
investments to improve AP and AR, but there doesn’t seem
to be a holistic approach to addressing the issues that make
everything work together,” DeRito says. “Too many AP and AR
departments are siloed, not talking to each other within the
company. If you are making a multimillion-dollar investment in
an ERP system, why not get the most out of it?”
The goal is to be able to use your ERP system to migrate into
a new environment without recoding the entire system, DeRito
says. “Every time the tax code changes, you should be able to
upload new rate structures. The system should be scalable. If
it’s not, you’re really losing the value these systems can provide
for transaction data.”
Beyond the technology, a return to basic accounting practices
seem to be in order.
AR professionals
must properly do
the math on every
transaction and
not assume that a
computer system
will correct all
calculations.
“It seems painfully obvious, but it’s a point that cannot
be overemphasized,” Sensiba San Filippo’s Norwalk says.
“Mathematical errors on a form show a lack of care or a lack
of competence. Either way, you will increase your likelihood of
having the IRS sniff around to see what’s going on.
“And look at the sales tax returns and ensure that they reconcile
with your sales figures,” he says. “If the sales tax returns don’t
agree with the income tax returns, you could have problems
with IRS and state tax audits. If you have large dollar figures
that don’t compute, it may indicate that mistakes were made
right out of the gate. You’re almost asking for an audit.”
Tips for avoiding—or
surviving—an AR audit
Often, simple oversights can trigger audits as easily as more
complex and complicated matters.
Here, we offer ways a company can impact its own chances of
being selected for a tax audit, or, if you are selected, ways to
streamline the audit process.
1
2
Watch those liabilities. Check your liability accounts
(including deferred income) to ensure that any potential
income items have been properly recognized.
Keep your data safe. Your accounting records are only as
good as the latest version you have access to. Regardless
of how your accounting system is hosted (onsite or off,
as many companies today are using cloud computing
resources), implement a regular, preferably offsite, data
backup to ensure that any local disruption will cause only
minimal data loss.
3
Check your commissions. To check the level of sales
being reported, the IRS looks at average commission
expense percentage and extrapolates approximate sales.
If your company relies heavily on a commissioned sales
force, make sure these two accounts are in line, or that
significant discrepancies are explainable.
4
Don’t stray from the trial balance. Ensure that
revenues reported on sales tax and income tax returns tie
to the trial balance. This is an easy check, and differing
revenue numbers are an easy flag for a tax auditor.
5
Dwell on the negative (balances). Scan your accounts
receivable subsidiary ledger for credit balances to ensure
these balances reflect customer overpayments or advance
payments.
6
Fill out your tax returns completely. Answer all the
questions on the tax return to the best of your ability—do
not leave blanks, which may lead to queries from the IRS.
Use your tax return as an opportunity to communicate
with the taxing authority—transactions that may appear
84 September-October 2010 AP Matters Today AR Matters

questionable or which cause a significant one-time
fluctuation in sales or expenses that might raise questions
should be explained in a footnote or otherwise delineated so
as to pre-emptively quash any questions that might arise.
Of course, there’s no need to explain everything—just items
that are so unusual they might raise questions.
7
Cross your T(account)s. Review any debit entries in
the sales accounts in your general ledger. The tax auditor
often looks to these accounts to check for mis-postings that
have impacted reported sales instead of properly impacting
accounts receivable.
8
Don’t guess. Use exact figures. Estimates and
approximations should be left off the tax return. Of course,
you’ll want to have clear backup and substantiation for all
amounts reported.
9
Tighten up the books. Ensure that your accounts receivable
ledger detail ties to the trial balance. Look for unusual items
in the AR control account; entries that do not originate from
the sales or cash receipts journal may bear exploration.
10
Do the math. Simple mathematical errors almost always
trigger an immediate query from the IRS and other taxing
authorities. Avoid this by double-checking your calculations
(or those of any software programs you might be using),
paying particular attention to any items that have been
overridden or manually input to ensure that any ensuing
calculations flow correctly.
Source: Sensiba San Filippo
More tips for avoiding
an AR audit
Here are additional “simple steps” AR professionals can keep
in mind and/or act upon in order to avoid an AR audit.
Michael R. Bryant, National Association of State
Boards of Accountancy (NASBA)
• Time is money. “The longer a balance is outstanding, the
riskier the collectability. The longer you let AR go uncollected,
the less valuable it becomes.
• Don’t fold under pressure. AR gets a lot of pressure from
customers to extend terms that are more favorable than
the company would like. Be polite but firm in maintaining
your company’s receivables policies so you don’t put your
company at a disadvantage.
• Flag accounts in advance. Watch for signs that make
you suspect something may be odd about a particular
account. If a slow-paying client is having trouble paying
you, be prepared to cut off credit if necessary.
Douglas J. DeRito, Ryan Inc.
• Ensure proper internal controls. Make sure the data is
easily understood and supports the management reporting
function you need to fulfill. Don’t just process numbers, but
understand that there are controls in place to mitigate risk.
• Have good data processes in place. Make sure AR can
explain the transactions—not just process the numbers.
If you don’t collect proper taxes, it becomes your liability.
If the auditors don’t see tax broken out as a separate line
item in both the rate and the jurisdiction, more than likely
that tax will not be remitted to anyone. That will trigger an
additional liability.
• Be more transparent. Look at the level of dollars involved
with each transaction. Some companies build thresholds as
a means of control. Review high-dollar transactions over a
certain level determined by the value of transactions, for
example, or average type of invoice sent out the door. That
could identify any issues.
• Nip it in the bud. Beware of duplicate payments. Put some
controls in place, such as a monthly management report,
that enable a set of checks and balances against erroneous
payments. Go through a reconciliation process each month to
determine the average payment, such as Net 30 or Net 45.
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AP Matters
Today
AR Matters
September-October 2010
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