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Computers, Electronics and High Tech Industry Edition

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IRS Tax Audit Manual for Computers, Electronics and High Tech Industry

NEVER AGAIN FEAR AN IRS TAX AUDIT!

The IRS MANUAL written specifically for Internal Revenue Service Audit Agents to use while conducting audits of taxpayers in the Computers, Electronics and other High-Tech Industries.

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The Internal Revenue Service Identifies A Case With Ideal Audit Potential!

This is the exact information provided to Auditors by the Internal Revenue Service to help them determine if a taxpayer is ripe for “adjustments” – By the way…”adjustments” means tax dollars – YOUR tax dollars!

All cost of sales examinations should begin with identification and reconciliation of Schedule M-1 cost of sales and inventory accounts to the corresponding general ledger or trial balance. This analysis may reveal the major inventory accounts you may wish to examine further and clue you to possible issues related to nonstandard journal entries or reserve accounts.

At this point, care must be taken in deciding to proceed with and in-depth audit plan for cost of sales, as even a significant adjustment to ending inventory produces subsequent year inventory debits. A compliance decision must, therefore, be considered with focus of materiality. This study revealed specific non-compliant areas, which indicate audit potential.

  1. No Physical Inventory Counts Taken (IRC Section 471)
  2. Failure To Inventory Overhead Cost, Direct Labor, or Both
  3. Failure To Implement IRC Section 263A (File F3115). If The taxpayer properly elected the change, an IRC Section 481(a) adjustment should be present of Schedule M-1 through the past 10 taxable years.
  4. Utilization of the Gross Profit Method for inventory valuation. This method is specifically not allowed. See change in Accounting Methods, IRC Section 481(a). Or, utilization of the Cash Basis method of accounting

NOTE: If comparative Gross Profit percentages are inconsistent, the dollar amount of Direct Materials Costs in Finished Goods (FG and Work-In-Progress (WIP) is high in relation to Total Inventory (greater than 30%), AND inventory Turnover Rate is low, YOU HAVE A CASE WITH VERY GOOD TAX ADJUSTMENT POTENTIAL.

A cash basis taxpayer who has inventory, but does not recognize inventory, faces two potential audit adjustments. An adjustment requiring the recognition of inventories would be proposed under the authority of IRC Section 471. The other adjustment mandating the use of the accrual method would be supported by IRC Section 446.

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TABLE OF CONTENTS

  • CHAPTER 1: INVENTORY AND COST OF SALES
    • Introduction 1-1
    • General Background 1-1
    • Cost of Sales (COS) Characteristics 1-1
    • Case with Ideal Audit Potential 1-2
    • Unique Industry Characteristics 1-3
    • Inventory Issues Found in Electronics Industry 1-4
    • Audit Techniques 1-4
    • Initial Examination Procedures 1-4
    • Cost Analysis 1-8
    • Cost Identification 1-8
    • Burden/Allocation of Indirect Cost to
    • Inventory 1-10
    • Mixed Service Cost Allocation Methods 1-11
    • Ending Inventory Allocation Methods 1-12
    • Standard Cost Variance Treatment 1-13
    • Inventory Reserve 1-14
    • Introduction 1-14
    • Non-Manufacturer 1-15
    • Manufacturer 1-15
  • CHAPTER 2: RESEARCH AND DEVELOPMENT
    • Introduction 2-1
    • IRC Section 174:
    • Definition of Research and
    • Experimental Expenditures 2-1
    • IRC Section 41:
    • Definition of Qualified Research Expenses 2-2
    • Computer Software Development Costs 2-7
    • Revenue Procedure 69)21, 1969)2 C.B. 303 2-7
    • Proposed Amendments of
    • Treas. Reg. section 1.174)2 2-8
    • FASB #86 Computation of
    • IRC Sections 174 and 41 2-9
    • IRC Section 280(C)(c)(3):
    • Reduction of Credit Versus Expense 2-11
    • Base Amount Computation 2-11
    • Alternative Minimum Tax 2-13
    • Research and Development Tax Shelters 2-14
    • Audit Techniques 2-14
    • General Techniques 2-14
    • Wages 2-15
    • Supplies 2-16
    • Contract Research Expenditures 2-16
  • CHAPTER 3: DEFERRED REVENUE
    • Introduction 3-1
    • Financial Accounting (GAAP)
    • Versus Tax Accounting 3-1
    • Difference Between GAAP and
    • Tax Accounting 3-2
    • GAAP Rules for Revenue Recognition 3-2
    • Tax Rules for Revenue Recognition 3-3
    • Deferred Revenue Situations in the
    • Computer Electronics Industry 3-4
    • Deferred Revenue Service Agreements 3-4
    • Revenue Procedure 71)21 3-4
    • Deferred Revenue Sale or
    • Manufacture of Goods 3-8
    • Advance Payment for Goods 3-8
    • Treasury Regulation Section 1.451)5 3-8
    • Distributor Sales 3-11
    • Audit Techniques 3-12
    • Pre-Audit Analysis 3-12
    • Interview 3-13
    • Other Sources of Information 3-13
    • Books and Records 3-14
  • CHAPTER 4: INTERNATIONAL ISSUES
    • Introduction 4-1
    • International Enforcement Program
    • Referral Criteria 4-1
    • Case Examples 4-2
    • Wire Transfer ) Lack of Documentation 4-2
    • Expenses of a Foreign Subsidiary Paid by
    • U.S. Corporation 4-2
  • BIBLIOGRAPHY B-1
  • GLOSSARY OF ELECTRONIC INDUSTRY TERMS G-1
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