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Part 4. Examining Process

Chapter 47. Computer Audit Specialist

Section 3. Statistical Sampling Auditing Techniques

4.47.3  Statistical Sampling Auditing Techniques

4.47.3.1  (08-31-2002)
Background

  1. The Office of the Chief Counsel and the Department of Justice have jointly analyzed the legal ramifications of utilizing probability sampling techniques in the examination of large accounts, and have concluded that substantial authority exists for the determination of tax deficiencies based on statistical samples.

  2. Statistical sampling techniques are valuable examination tools where effective use of resources makes it uneconomical to audit voluminous accounting data. Proper use of statistical sampling substantially increases the quality of IRS examinations.

4.47.3.2  (08-31-2002)
Objective

  1. The Statistical Sampling Auditing Technique's objective is to maximize the effective use of statistical sampling in IRS examinations, and at the same time:

    1. ensure that estimates of adjustments to tax liabilities resulting from statistical samples are statistically sound and legally defensible; and

    2. ensure the fair and equitable treatment of taxpayers examined by using statistical sampling techniques.

  2. In attaining this objective, the National Program Manager will:

    1. explore and identify areas where statistical sampling may be used to improve the quality and effectiveness of examinations, investigations, and compliance projects;

    2. identify and develop the tools necessary for implementing statistical sampling in examinations;

    3. provide training recommendations and assist in the development of training for examiners at all levels; and

    4. coordinate and monitor the use of statistical sampling by providing mechanisms for distributing technical information and providing technical assistance.

4.47.3.2.1  (08-31-2002)
Program Management

  1. The responsibility for the statistical sampling auditing techniques resides with the National Program Manager – Computer Audit Specialist, Field Specialists LMSB. All correspondence relating to the program should be addressed to the attention LM:FS:CAS.

4.47.3.2.2  (08-31-2002)
Statistical Sampling Coordinator

  1. Each territory will have at least one statistical sampling coordinator. The role of the statistical sampling coordinator includes:

    1. reviewing statistical samples conducted by other CASs.

    2. assisting the CAS in the development for complex samples.

    3. discussing complex statistical sample issues with internal and external legal counsel and outside experts.

    4. teaching Training Course 3172 and 3174.

    5. developing and delivering training to other CASs in the form of group meetings, CPEs, technical conferences, etc.

  2. It is imperative that the Statistical Sampling Coordinators have the highest level of expertise. Additional training should be provided to them beyond the Training Course 3174.

4.47.3.2.3  (08-31-2002)
Training

  1. Training Course 3172, Statistical Sampling for Examination Personnel, is the basic course in statistical sampling, designed for revenue agents, grade 11 through 13. This course contains the instruction necessary for an otherwise experienced revenue agent to apply a simple statistical sampling technique on a case he/she is examining. Revenue agents should not independently undertake a statistical sampling without having successfully completed Training Course 3172 or its equivalent.

  2. Training Course 3174, Advanced Statistical Sampling for Examination Personnel is primarily designed to train computer audit specialists who provide statistical sampling assistance to examiners. It contains an in-depth discussion of the basic concepts taught in Course 3172 plus a discussion of more advanced statistical sampling auditing techniques, and assumes a basic knowledge of computer concepts. The course is available to persons other than computer audit specialists only on an exception basis.

  3. Other training courses may be developed to assist the CAS and the Statistical Sampling Coordinators.

4.47.3.2.4  (08-31-2002)
Requests for Assistance

  1. Assistance in the application of statistical sampling in examinations is available through the Computer Audit Specialist.

  2. Requests for assistance will be made through the normal CAS referral process.

4.47.3.3  (08-31-2002)
General Instructions

  1. Projections obtained from examination of statistical (probability) samples of accounting records may be used as the basis for proposing adjustments to items reported on a tax return.

  2. Statistical sampling should be considered whenever a group of accounting entries or transactions has sufficient adjustment potential to warrant examination, but the examination of the totality of all such transactions is prohibitive in terms of time and resources. In any audit situation where it is reasonable to examine 100 percent of the items under consideration, statistical sampling techniques should not be used.

  3. The precision of any statistical sample to some degree is based on the sample size used. With estimation sampling plans, optimum sample sizes can be determined from a preliminary sample. Where feasible and within the examination constraints, preliminary samples may be used to estimate a supplemental sample size which when added to the original results will achieve the desired degree of precision required by the plan.

4.47.3.3.1  (08-31-2002)
Determination of Proposed Population Adjustment

  1. As a general rule, the proposed population adjustment will be determined, such that, 95 percent of the time, it will not be greater than the actual adjustment obtainable by a 100 percent examination of the population. This applies regardless of whether the adjustment favors the government or the taxpayer.

  2. Using the most conservative limit of the estimated population adjustment at the 95 percent confidence level will attain the above result. (The estimated population adjustment is also referred to as the point estimate.) This most conservative limit will generally be computed by subtracting the sampling error from the point estimate. In making the computation, the following specific rules should be applied; in applying these rules, an adjustment that reduces an expense or increases income is considered positive in sign.

    1. If the point estimate is positive and greater than the sampling error, the proposed population adjustment is obtained by subtracting the sampling error from the point estimate.

    2. If the point estimate is positive and is less than the sampling error, either select additional sampling units to attempt to reduce the sampling error or abandon the sampling plan and propose only those adjustments specifically identified.

    3. If the point estimate is negative, and the sampling error is less than the absolute value of this adjustment, the proposed population adjustment is obtained by adding the sampling error to the point estimate.

    4. If the point estimate is negative, and the sampling error is greater than the absolute value of this adjustment, either select additional sampling units to attempt to reduce the sampling error or abandon the sampling plan and propose only those adjustments specifically identified.

  3. An exception to the general rule, stated in (1) above, occurs whenever any of the following occur:

    1. the Code or Regulations provide for determination of portions of a tax liability on what may of necessity be an estimated value (e.g., certain determinations of fair market value or inventory values),

    2. the taxpayer does not carry their burden of recordkeeping by providing records sufficient to determine a reasonably accurate tax liability,

    3. the sampling error at the 95 percent confidence level is immaterial in relation to the point estimate, or

    4. the taxpayer and the government mutually agree on a specific methodology for projecting the sample result to the population.

  4. Under such circumstances as stated in (a) above, it is appropriate to use the methodology and requirements as directed in the Code or Regulations. In the case of (b) and (c) above, one may use the point estimate as the basis for the proposed adjustment.

  5. Whenever two or more accounting populations for a particular tax return are combined and examined with the aid of a statistical sample, the sample result and sampling errors can be combined according to the rules for a stratified sample. However, combining accounting populations which cross natural account categories may cause difficulties for Revenue Agent Report (RAR) and Notice of Deficiency purposes; therefore, examiners are to exercise caution in this regard.

  6. When sampling the same accounts for multiple years, where a single projection does not materially affect other computations that are more appropriately made on a yearly basis, it is permissible to combine the accounts into one population. The combined result should be allocated in a reasonable method that is determined prior to the selection of the sampling units.

4.47.3.3.2  (08-31-2002)
Sampling Procedures

  1. (1) Sampling units should be selected for the sample based on random number selection techniques.

  2. Any unusually large transactions should be grouped into a separate stratum and examined in their entirety. Transactions should only be considered unusually large.

  3. In stratified sampling situations, a stratum could be deleted or added to the population without affecting the validity of the sample; however, there should be sound reasons for doing so.

  4. The examiner must come to a conclusion as to the correctness of each item in the sample. It is never valid to replace a sample item that is included in the sampling design with another sample item which is not included in the sampling design, merely because documentation is unavailable or difficult to obtain.

  5. The decision reached as to the validity of any sample item must be the same as the conclusion which would be reached if that item were encountered in a 100% examination.

4.47.3.3.3  (08-31-2002)
Related Entries Originating from a Sampled Transaction

  1. All business transactions generate a minimum of two accounting entries. Frequently, multiple entries are generated. The correctness of a particular entry, whether sampling is used or not, can only be determined by reviewing the transaction in its entirety.

  2. In analyzing individual entries generated by a transaction, the examiner must deal with two types of problems: determining the validity of an entry, and determining the associated adjustments to other accounts when errors are encountered. These problems must be properly dealt with in any audit; however, if sampling techniques are being used, special care must be taken. The following principles should be observed when using sampling methods.

    1. Adjustments Within Sampled Accounts:

      1. The examiner should review the basic documents supporting a sample entry in order to determine how the taxpayer handled the entire transaction. If the examiner feels the transaction was handled improperly, it must be decided how it should have been handled.

      2. The way the examiner allocates adjustments among the various entries must not be influenced by which entries are drawn in the sample and which are not.

      3. If, within a population which is to be sampled, errors in specific entries are known to exist beforehand, these entries, if substantial, should be separated into a separate stratum and examined in their entirety. However, if after the sample is drawn, specific adjustments to items not part of the sample are discovered, projections must be based only on items selected in the sample. This does not preclude making adjustments to related entries in other accounts that are not subjected to sampling; nor does it preclude the option of abandoning the sample and proposing only those adjustments specifically identified.

      4. No adjustment to a sample entry should be made unless that particular entry can be shown to be in error. The amount of the adjustment to a sample entry should not include any adjustment that properly belongs to some other entry.

      5. The conclusion reached in determining if an adjustment should be made to the value of a sample item should be the same as if a 100% examination of the population was conducted. For example, the value of a sample item that has been totally offset by a reversing entry is to be considered correct and should not be adjusted.

    2. Associated Adjustments to Other Accounts:

      1. When adjustments are made to sample entries in an expense account, the normal procedure for making associated adjustments to asset accounts, depreciation, investment credit, etc., cannot be followed. As the adjustment to the sample items will be projected to a larger total, so must the associated adjustments be projected to a corresponding level.

      2. A common example of an associated adjustment is when a currently expensed item is determined to be capital in nature. Since the projected adjustment from capitalized items will generally be based on the lower confidence limit of the estimated population adjustment, the ratio of the lower confidence limit to the amount of adjustment in the sample (before projection) can be used to derive the projected value of the associated adjustment characteristic. It must be remembered, however, that these projected adjustments represent aggregate values rather than specific identifiable assets. Although the prior example will likely be a common method utilized, other reasonable methods may also be used.

      3. Projected depreciation write-offs in subsequent years can be determined by first computing the depreciation which would be allowable on the items in the sample (without projection) and then applying a multiplier as described previously to gross up the allowable depreciation to an amount equivalent to the original projection. The ultimate result is to allow depreciation over time in an amount equal to the projected value for capitalized items.


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