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SAMPLING TECHNIQUES

Sampling is a large and important part of the examination of a tax return. It is the application of examination procedures to less than 100% of the items in an account to evaluate its accuracy.

A. Two Basic Types of Sampling

Sampling is a large and important part of the examination of a tax return. It is the application of examination procedures to less than 100% of the items in an account to evaluate its accuracy.

  1. Statistical Sampling - is the formal mathematical selection and examination of transactions, amounts or accounts based on the probability that moderately large number of items taken as samples will produce results from which conclusions may be made.
  2. Judgmental Sampling – it is applied when selecting accounts and transactions to be tested as it involves the use of professional judgment in planning and performing the sampling and analyzing the results.

Judgmental sampling may include any or both of the following methods:

  1. Block Sampling - uses groups of continuous items selected from an account balance or class of transactions.
  2. Peso limitation sampling or cut-off sampling - selects a minimum peso amount and transactions in excess of the said amount are verified.
B. Factors to be Considered in Planning the Sample
  1. Internal Control - The extent of sampling to be done is dependent on the degree of internal control. Thus, a small sample size is required if internal control can be greatly relied upon.
  2. Accounting System - Large errors or high frequency of errors in the accounting system may require a large sample size.
  3. Materiality - In choosing appropriate material limits, the absolute size of an item, the relative size and the nature of the business, and industry/ business practice should be considered. Materiality of an item should be related to its tax consequence.
  4. Analytic Review - In analytical review, the following considerations should be studied:
    1. Taxpayer’s standard of living
    2. Interest in closely held companies
    3. Transactions between related parties
    4. Transactions involving questions of fraud
    5. Significant increases or decreases in taxable income from year to year
    6. Significant adjustments on previous Revenue Officer’s reports

C. Sampling Techniques to be Applied in Testing Accounts and Transactions

Listed below are the suggested sampling techniques in testing income statement and balance sheet items:

  1. Select the first and last months of sales to ensure that income was not deferred to an improper year.
  2. The last month of the period under examination should be tested because of the likelihood of errors and unallowable adjustments made before the end of the year.
  3. Selection of the largest three months’ incurrence of an expense account may reveal expenses that should be capitalized, personal expenses or padded expenses.
  4. Scan the cash disbursements journal and general ledger for unusual or very large entries. This step also familiarizes the Revenue Officer with the accounts, payees, suppliers and clients of the taxpayer.
  5. Select at least one month’s (or one week for a large corporation) file of cancelled checks. Thoroughly analyze each check together with the endorsement at the back. This could lead to the discovery of fictitious payees, unusual transactions, personal items charged to expense and other possible disallowances.
  6. Inspection of the corporate minutes and the articles of incorporation could lead to a Revenue Officer’s determination to sample a particular account.
  7. Examine certain accounts in the income statement in relation to the balance sheet accounts.
  8. Test-check source documents and related transactions by considering the persons involved, nature of the contract, mode of payment and other important aspects.
  9. Rounded figures should be checked as they may be estimates.
  10. Utilize results of analytical review in selecting the sample.
  11. Contract or limit the scope of the sample if the majority of the samples are completed and there are still no discrepancies.

D. Examining the Sample Items

The sample items, as selected, should be verified as follows:

  1. Analyze and determine the validity of the source documents.
  2. Examine collaborating documents.
  3. Check with third parties.
  4. Inspect and observe inventory flow, fixed assets acquired, sales transactions and other transactions which may require ocular inspection.

E. Analyzing the Results

Analyzing the results of a sample is an important yet commonly missed step. The sample taken should be evaluated and considered in relation to any peculiar situation, such as related-party transactions or economically unsound transactions.

If the results of the sampling indicates potential tax assessment, an in- depth analysis should be conducted as follows:

  1. Verify the account showing the discrepancy or possible source of tax deficiency.
  2. Trace the audit trail involving the transaction.
  3. Perform a 100% verification such account.
  4. Consider performing third-party checks to substantiate transactions.
  5. Take a close look at how the taxpayer handled the entire transaction.
  6. Consider the adjustments associated to other accounts.
  7. Discuss the problems or discrepancies with the taxpayer or his authorized representative.

F. Concluding the Sampling Results

The audit samples should be clearly documented in the working papers from which a conclusion shall be drawn. If a quality sample analysis has been performed, it will be easy to form a conclusion from the sample results. The conclusion reached should be clear, concise and final.