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:: New Vehicle Dealership Audit Technique Guide 2004 - Chapter2 - Books and Records (12-2004)   Chapter 2 - Table of Contents Characteristics Books and Records General Ledger Audit Example Conclusion Characteristics The books and records of an automobile dealership whose efforts are concentrated on the sale of new vehicles have several features the examining agent should keep in mind before and during the audit process: Voluminous Records With literally hundreds of books, thousands of accounts, and millions of entries, new automobile dealerships may have the most "full" set of books and records of any non-regulated, non-traded company. Chart of Accounts, source codes, grouping papers, and the manufacturer's accounting manual are the key to not getting lost and conducting an effective audit. These books are almost exclusively in an electronic format with subtotals carried forward throughout the course of the year. Overwhelming Voluminous records, in conjunction with experienced taxpayers and representatives, make the agent's job difficult at first. A well-planned and organized audit will help the examiner focus the examination, mitigating the "overwhelming" factors. Financial Statements One of the most important tools is the manufacturer's statement, which is prepared regularly (usually monthly) and sent to the manufacturer, who keeps well abreast of the dealership's business operations. These statements are standardized per the factory manual and can be reconciled to tax items. This process can establish confidence in the books in order to curtail reconciliatory and verification activities. Accounting Manual Each factory has its own accounting manual, typically 500 pages or so of format and procedure. This is a must for the examining agent and should be obtained for use at the beginning of the audit. The manual should be used as a tool throughout the examination. Similarities and Differences The books and records are different from dealership to dealership, but given the control imposed by the factory manual, any dissimilarity is made to conform to the same final form. As such, it is important to determine those characteristics that account for differences between dealership entities, as tax consequences may relate to the different methods. Traditional Books An automobile dealership has all the traditional books with significant detail as well as a large set of subsidiary ledgers. General Ledger Journals – The traditional books General Sales Purchases Cash Disbursements Journal Cash Receipts Journal Payroll Journal Sources: Auto dealerships journalize these five traditional books into many sub-journals using source codes to identify a particular transaction and the particular source book it is journalized to. These sub-journals, which include the traditional books, may number as many as fifteen.  Subsidiary Ledgers Starting the examination The audit should start and proceed from the accountant's (preparer's) work papers and the general ledger in order to determine focus and familiarize the agent with the specifics of the books. A recommended process is:  Reconcile General Ledger to working papers. Group - Use accountant’s papers to group accounts into return items. Reconcile - Beginning Trial Balance and Adjusting Journal Entries to the tax return. Reconcile - Beginning Trial Balance to General Ledger. Structure of the General Ledger The General Ledger (GL) is prepared monthly and is cumulative, summarizing entries made to each account by the journals. Being computerized, source codes are used to post summaries of monthly journal entries to the General Ledger accounts. Without a key of the source codes, one does not know from where an amount originated. Journal Voucher Entries The Journal Voucher book contains items which alter the General Ledger to correct errors, account for standard recurring items, and make tax adjustments.          Standard Entries Items such as Amortization and Prepaid expenses, which are periodically being adjusted, are done through Journal Voucher entries.         Errors The correction of errors, which posted to the General Ledger, the Journals, or the subsidiary ledgers, is also done through the Journal Voucher.         13th Month Entries At the end of the taxable year, and prior to the preparation of the Trial Balance, several entries are made which constitute corrections to previously recorded errors and adjustments in yearend account balances for federal tax purposes. These 13th month entries generally address accruals, writedowns, the LIFO reserve and elimination of book reserves, to name a few. These entries are prevalent in the auto industry and are usually identifiable by a unique source code in the General Ledger. Schedules In addition to the typical books and records, auto dealers also maintain a number of various subsidiary ledgers that may assist in the examination. Examples of such subsidiaries include: Accounts Receivable: List of customers and account balances. Accounts Payable: List of vendors and account balances.  New Vehicles: Stock number, cost, amount floored (short-term loan from bank for automobiles purchased), etc; Perpetual versus physical inventory listings. Separate Folders Certain items, which do not require a living ledger, are kept track of by the typical dealership. Examples include: Fixed Assets Prepaid Expenses Other Dealership records to be aware of Report of Sales Book: In California, it is required that all sales be reported to the Department of Motor Vehicles within 5 days of sale in order to register the vehicles. Analysis of this record will ensure the sales cutoff is proper at the beginning of the year and at yearend. Agents should foot a sample to assure all sales are recorded in the general ledger. Car Jackets: A separate folder for each new vehicle sold which contains documentation pertaining to this particular transaction. Remember, each dealership is different and, therefore, it is paramount the examining agent require someone truly familiar with the books and the business to detail the operations and the accounting system at the initial interview.  Books and Records General Ledger Audit Example Picture a General Ledger of about 10,000 pages for the year with only numeric reference points to various transactions. In order to effectively sample items, a connection to source documents is necessary. It is common where new car auto dealerships are concerned to break down the 5 traditional journals, (i.e., Sales, Purchases, Cash Disbursements, Cash Receipts, Payroll), into 15 different journal sources, with 15 applicable source codes to represent and include these traditional books. Such a journal source setup could look like the following, this is an example of one of the computer vendors used by auto dealerships: Source Code Description 1 New Vehicle Sales 2 Used Vehicle Sales 3 Repair Order Sales 4 Parts Sales 5 Cash Receipts 6 Cash Disbursements 7 New Vehicles Purchases 8 Used Vehicle Purchases 9 General Purchases 10 Dealer Trades 11 General Adjustments 12 Prior Year Adjustments (13th month adjustments) 13 Standard Entries 14 Warranty Credits 24 Payroll Each Source Code representing a source journal is typically divided into monthly books, for example: Source Code – 7 New Vehicle Purchases January 1 February 2 March 3 April 4 etc… Using our scenario above, where we have 15 source codes and a different book for each quarter, it would not be inconceivable to have 60 journal source books for one tax period. These concepts can become a little muddled where these journal source books are straddled around a fiscal yearend with quarters that do not conform to what are considered "traditional quarters," or the dealership maintains a separate set of source books for each manufacturing line sold (i.e., one set of journal sources for manufacturer A and a separate set for manufacturer B). There would be 120 journal source books for one tax period using the criteria set forth above.)  Where the agent wishes to sample an item from the General Ledger, the source code should be secured and then the source journal should be referenced corresponding to the quarter of posting. Then descriptions become more revealing and appropriate source documents can be requested. The typical item posted to a General Ledger using this journal source method would resemble the following: General Ledger 11/0X 7             $1,000 What does this entry mean? Remember these postings represent a summary of monthly activity occurring in that particular journal source posted to the general ledger. This particular entry indicates the month of November 200X had activity of $1,000 that was summarized and posted to the General Ledger emanating from Journal Source book 7. Reviewing our journal source codes we find that Journal Source 7 represents New Vehicle Purchases. To find this particular entry we would go to that particular Journal Source 7 book which incorporates the summaries for November 200X. Inspection of that book reveals entries that would resemble the following: 7 New Vehicle Purchases Date  Invoice # Description  Amount 11/1/0X 111111 New Car  $100.00 11/2/0X   222222  New Car $200.00 11/3/0X  333333 New Car  $300.00 11/4/0X  444444 New Car $400.00 Journal 7 New Vehicle Purchases Total                                        $1,000.00 The agent may now request specific invoices or flooring statements pertaining to the entry originally noted in the General Ledger, as necessary. Each journal will have its own unique source documents: Source Code Description Probable Source Documents 1 New Vehicle Sales Car Jacket 2 Used Vehicle Sales Car Jacket or aggregated files 3 Repair Order Sales Folders or invoices 4 Parts Sales Invoices 5 Cash Receipts Bank Statements (by bundle #) 6 Cash Disbursements Bank Statements (Checks by bundle #) 7 New Vehicles Purchases Flooring Statements, invoices 8 Used Vehicle Purchases Car Jackets, Cash Disbursements 9 General Purchases Usual substantiation documentation 10 Dealer Trades Invoices 11 General Adjustments Dealership Internal accountant's work papers and journal entry sheets 12 Prior Year Adjustments (13th month adjustments) Work papers and individual AJEs 13 Standard Entries Usual substantiation 14 Warranty Credits Car jackets, transaction statements 24 Payroll Payroll company books and records Electronic Records Requirement for Dealer Software Automobile dealerships utilize computer software specifically designed for a particular dealership or from the manufacturer for use at the dealership. Revenue Procedure 98-25 sets guidelines for the requirement of a dealership to retain electronic records. This revenue procedure specifies the basic requirements for the establishment, maintenance and retention of a taxpayer’s records are maintained within an Automatic Data Processing (ADP) recordkeeping system. The requirements of this procedure are applicable to all Internal Revenue Code provisions that have unique or specific recordkeeping requirements. Rev. Proc. 91-59, 1991-2 CB 841, was modified and superseded for machine-sensible records relating to tax years beginning after December 31, 1997. However, taxpayers that comply with this procedure for tax years beginning prior to that date will be treated as having complied with Rev. Proc. 91-59 for those years. With regard to a dealership’s information system: The manufacturers and distributors mandate the specifications of dealership accounting systems. Dealerships have a limited number of hardware and software vendors from which to choose. The transfer of data from one vendor’s product to another is difficult or impossible. Information systems are typically relatively small and do not store information from prior cycles. Back up tapes might be made but typically are not retained for an extended period. If back up information is available; it generally cannot be loaded back onto the dealer’s system without removal of the current activity. Information systems contain proprietary software that usually cannot be accessed by a Computer Audit Specialist. Dealers communicate with manufacturers through a Dealer Communication System (DCS) that generally allows a dealership to order vehicles and parts, submit warranty claims, and send other communications to the factory. Dealerships increasingly use the Internet and e-mail to communicate with customers, manufacturers, and other partners. Some dealers have entire departments devoted to providing e-mail responses to prospective clients. Conclusion Although intimidating at first, the books and records of an automobile dealership are usually very complete. However, a structured audit plan and the knowledge of the accounting procedures employed by the dealership will provide the necessary tools to do a thorough examination. Therefore, it is crucial that some understanding of the records exist prior to the issuance of even the first IDR. Given this comprehension, the auditor should have all the necessary information to get started.

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