Audit Manual, Ch 3, Sec 3.3 - Books and Records

3.3 Books and Records

The examination of books and records is divided into two parts. The first is the examination of acknowledged payroll, and the second is the review of other records that may reveal hidden wages. Each Auditor is required to examine at least one record type that is a source document during the course of the audit.

Payroll maintenance varies among employers. This affects the number and types of payroll and related records that are available for audit. The Auditor must determine what records the employer maintains, and also what payroll procedures are used. Learning what payroll records are available - from time card preparation all the way through to the final recording of wages paid - is extremely important in auditing an employer's payroll records.

In addition to reviewing the employer's payroll records, other business records must be examined for unreported wages. Many small employers do not maintain sophisticated records of payments for other business expenses. At a minimum, the Auditor should examine and analyze the employer's record of disbursements in an effort to locate hidden wages. The disbursement records in a very small business may consist only of cancelled checks and check stubs.

3.3.1 Records of Acknowledged Payroll

The books and records listed in this section contain payroll information about the employer's acknowledged employees.

NOTE: The letters "S.D." denote a source document.

Individual Earnings Records (IER)
A chronological detail that shows some or all of the following information: each employee's name, social security number, home address, date of birth, job description, date of hire, gross amounts of wages, date of payments, deductions, net amount of wages and usually have totals at the end of each quarter and at year end. An IER is a record of acknowledged payroll, thus it is not an adequate source for discovering “hidden” or “misclassified” wages.
Employees Pay Period Earnings Statement
The Employee's Pay Period Earnings Statement is a source document when direct deposit is used or the employee is paid in cash. Dated individual slips of paper may contain the employee's name, social security number, number of hours worked, rate of pay, total gross wages, deductions and net wages for each payment made to an employee. The audit report must provide an explanation when this document is used as a source document.
Employer Benefit Programs
Employers normally keep separate records for benefit programs, especially 125(a) (cafeteria plans) and 401(k), 403(b), or 408(k)(6) plans (deferred compensation plans).
Federal Form 940
Wages are reported on Federal Form 940 for the purpose of computing tax owed under the Federal Unemployment Tax Act (FUTA). Because the current taxable wage base for FUTA ($7000) and the current taxable wage base for Texas UI ($9000) do not match, taxable wages reported on Form 940 may not match the taxable wage amount reported to Texas. Total wages reported to Texas may match the total amount of wages on Form 940, but there are times when even the total wage amounts will not match, such as with multi-state employment. This report indicates the employer's name, address, Federal Identification Number (FEID #), and total and taxable FUTA wages paid during the year.
Federal Form 941
Federal Form 941 - Employer's Quarterly Return of Withheld Income Tax and Social Security Taxes can be used to determine the number of employees being reported to the IRS. Total wages may not equal the amount required to be reported to TWC. This report includes the employer's name, address, FEID #, total wages, and tips paid during the quarter.
Federal Form 943
Federal Form 943 - Employer's Federal Annual Tax Return of Agricultural Employees provides the employer's name, address, FEID #, and wages paid during the year.
Federal Form 4070
Federal Form 4070 - Employees' Report of Tips to Employer enables employees to report tips each month. If an employee receives at least $20 in tips during any month, the dollar value of all tips received must be reported to the employer.
Federal Form W-2
Federal Form W-2 - Employee's Tax Withholding Statements are the employer copies of documents sent to individuals showing the yearly wage totals and tax deductions. They should be compared to wages reported by the employer and amounts listed on individual earnings records. The Auditor should compare names on the W-2's with the individuals reported on the quarterly tax reports. If W-2s are found for individuals who were not reported, the Auditor should determine why they were not reported, and decide if they should be reported to Texas. The W-2 form provides the employer's name, FEID #, the employee's name, social security number, and total wages earned for the year.
Federal Form W-3
Federal Form W-3 -Transmittal of Income and Tax Statement is a report which accompanies the IRS copies of all W-2's issued by the firm for the calendar year. The reconciliation of total wages, tips and other compensation listed on the W-3 with the amounts reported to TWC, can help identify additional wages that should have been reported to Texas. The total number of W-2 statements entered on the transmittal form can be used for the same purpose. The form also includes the employer's FEID #, name, and address. The employer may file more than one W-3 report, such as one with the W-2's for employees with social security numbers, one with the W-2's for employees without social security numbers, or one for hourly workers and one for management personnel.
Payroll Computer Printouts From A Payroll Reporting Company
If an organization uses a data processing company for payroll reporting purposes, the Auditor should examine other source documents. It is important to verify that all components of wages in Texas have been reported. Occasionally items which should be reported as part of an individual's gross wages are not reported to the payroll reporting company, simply because the employer is not fully aware that those items constitute wages. The employer may not have reported all acknowledged payroll to the reporting company. Note: When payment is made by direct deposit, cancelled checks are not returned to the employer.
Payroll Journal/Ledger
This record contains payroll information such as wages paid, salary advances, loans to employees, bonuses, commissions, etc. paid to employees.
Quarterly UI Contribution Reports
These reports may be filed in Texas or they may be reports required in other states.
Specialized Payroll Books (SD)
A variety of specialized payroll systems, such as the Pegboard System, where the only record is a carbon copy of the check. Information available includes the check number, the payee, and the amount of the check. Cancelled checks are not returned to the employer and there is no voucher system.
Time Clock Cards (SD)
The time clock cards are the employer's record of time worked by an employee and may include the employee's name, social security number, the rate of pay, the number of hours worked for a specific time period, the total wages paid, the deductions and the net pay. When gross wages paid are listed on the time clock cards, this document is considered a book of original entry and may be used as a Source Document while conducting the audit.
Timekeeper's Book
A record of payroll that contains the employee's name, social security number, date and number of hours worked, rate of pay, total gross wages, deductions, and net wages by pay period.
Worker's Compensation Report
Private sector insurance companies provide this insurance. Reporting is quarterly and gross wages should normally agree with gross wages reported to TWC. By law, the Worker's Compensation Report cannot be used to make a determination that a worker is an employee because some general contractors pay the worker's compensation insurance for other contractors working on a specific project.

3.3.2 Other Books and Records

In addition to records for acknowledged payroll, an employer may keep other business records, which should be examined for unreported or hidden wages.

NOTE: The letters "S.D." denote a source document.

Accounts Payable or Voucher Register
This is a listing of items, waiting for final approval to be paid. Services paid in cash may sometimes be found in the voucher register. Individual items may be traced back to the cash disbursement records if the item was approved and paid. Alleged independent contractors may be included in the voucher register.
Accounts Receivable Ledger
Monies owed to the employer may be repaid by service. The amount of credit given for services performed would be wages.
Balance Sheet
A summary report reflecting the financial condition of the business as of a given date. Normally accrued wages and accrued taxes are found under current liabilities. The balance sheet can provide evidence of receivables that could be subject to garnishment if delinquent taxes are owed.
Big Chief Tablets, Paper Sacks, etc.
These may be the only records an employer has if cash is used for payments, and should be considered source documents if all payments are made in cash. The record may include payments made, the payee's name, social security number, and amount of payment (gross and net) by day or week.
Cash Disbursement Journal (SD)
The cash disbursement journal provides information about cash transactions. Entries in the cash disbursement journal are usually supported by cash receipts, vendor statements, vendor invoices, or petty cash records. This record may also be used to identify casual labor, extra labor, and alleged contract labor. This journal is considered a source document for hidden and unreported wages, and it usually shows check number, name of payee, amount paid, date paid, accounting code (number or description) and invoice number.
Chart of Accounts for a General Ledger
The chart of accounts can serve as a resource for selecting ledger accounts where wage items may be found. The AE is usually not interested in accounts containing fixed assets, unless attachable assets are being sought. Ledger accounts that may indicate unreported wage information could be Cost of Sales, Expenses (such as officer's salaries, professional fees, casual labor, miscellaneous expenses), Current Liabilities (such as salaries payable), Other Assets (such as advances to officers or employees), or other accounts.
Check Register (SD)
A check register lists checks written by an employing unit. Normally the checks are numbered and entered consecutively in the check register. Unless the employer transacts all business on a cash basis, the firm will have a check register. Inspection of the check register may uncover payments made for contract labor, casual labor, part time help, etc. The check register can be used to discern where the employer's bank account is located and if the employer has more than one account. Banking information is of value if the employer becomes delinquent in payment of taxes. An item in a check register usually includes the payee name, the amount paid, the accounting code (usually a number) and the payment date.
Check Stubs/Cancelled Checks (SD)
Cancelled checks and/or check stubs are a good source of information on wage items. Many employers write deductions from an employee's wages on the check stub. In some cases cancelled checks are not returned and all that is available is the carbon copy of the check.

Check stubs/cancelled checks are considered source documents.

This record normally shows the name of the payer, the name of the payee, the name of the bank, the bank account number, the date payment was made, and the amount of the net payment. The check stub or cancelled check may also show total wages paid for the quarter or year-to-date, tax deductions, net wages, employee social security number, other payments, other deductions, and the account coding in the general ledger for the payment items.
Commission Earnings Records
This is a ledger showing commissions earned, draws against commissions, and an individual's account balances. This is usually kept separate from the Payroll Journal/Ledger.
Confidential Ledger
This is sometimes called a private ledger. The confidential ledger is normally kept by one responsible individual and is not available to all of the individuals performing accounting work. The confidential ledger may have wage information concerning one or more officers of a corporation or contain wage or other information considered confidential by the owner, partners, officers or accountant of an employer. The Auditor should ask if there is a confidential ledger and examine the ledger if it is kept. Information taken from this ledger should not be discussed with anyone except the individual authorized to discuss the contents.
Contracts With Independent Contractors
Written contracts for services by independent contractors will give terms of the work agreement and is useful in making a decision as to whether or not an individual should be considered an employee.
Corporate Charter
The Corporate Charter Articles of Association will verify the date the corporation was formed and the date it was allowed to commence business as a corporation. It will indicate the nature of the business, the incorporators, and the registered agent prior to any changes in the minute book.
Detailed General Ledger (SD)
The Detailed General Ledger combines the features of both a Cash Disbursement Journal and a General Ledger. Detailed information about each individual transaction is listed in the appropriate account in the general ledger. Besides the detailed information about each transaction, the account also shows summary monthly totals and sometimes year-to-date totals for the activity in that account. It is both an individual transaction record and a summary record of business payments in one ledger. Current computer systems often will not maintain both a Cash Disbursement Journal and a General Ledger.

Computerized system transactions are generally posted as they are entered. It is helpful to refer to the chart of accounts to see what account titles might be suspicious. The financial records of a computerized system are usually printed and stored in hardcopy format for each accounting period.

To qualify as a source document, the Detailed General Ledger must contain at least date of payment, type of payment (cash or check), check number, name of payee, and accounting code (number or description).
Federal Forms 1099
There are a number of different federal Forms 1099. It is important to review all Forms 1099-MISC during the course of a TWC audit. Form 1096 can be used to verify the number and the total dollar value of the 1099's that were issued.

FORM NUMBER		REASON FOR THE 1099
1099-A		Acquisition or abandonment of secured property.
1099-B		Proceeds from broker and barter exchange transactions.
1099-C		Cancellation of debt.
1099-DIV		Dividends and distributions.
1099-G		Certain government and qualified state payments.
1099-INT		Interest income.
1099-LTC		Long-term care and accelerated death benefits.
1099-MISC		Miscellaneous income.
1099-MSA		Distributions from a medical savings account.
1099-OID		Original issue discount.
1099-PATR		Taxable distributions received from cooperatives.
1099-R		Distributions from pensions, annuities, retirement, etc.
1099-S		Proceeds from real estate transactions.

Federal Form 1099-MISC
This form lists fees, commissions, and other compensation paid to persons that the employer believes are not employees, however it is possible that individuals receiving 1099's could be in employment under Texas law. If the Auditor determines the payments should have been reported as wages, adjustments would be needed. Although the 1099-MISC is for non-employee compensation, the Auditor should carefully review all forms issued to assure no wages were overlooked.

The form indicates the payer's name, address, and FEID #, as well as the payee's name, address, FEID # or social security number, and it also lists the amount of non-employee compensation.

REASON FOR ISSUING FORM 1099-MISC	WHEN TO ISSUE	POSSIBILITY OF WAGES
Payments for services by people not treated as employees	$600 or more	Perhaps
Prizes and awards	$600 or more	Yes, if given to an employee.
Rent	$600 or more	Perhaps
Royalty	$10 or more	No
Payments to crew members on a fishing boat or proceeds from sale of catch	All amounts	No
Payments to a physician, physician’s corporation, or other supplier of health and medical services. Issued mainly by medical assistance programs of health and accident insurance plans.	$600 or more	Perhaps
Fish purchases for cash	$600 or more	No
Crop insurance proceeds	$600 or more	No
Gross proceeds paid to an attorney	All amounts	No
Direct sales of consumer goods for resale	$5000	No

Federal Form SS-4
The Federal Form SS-4 Application for Employer Identification Number provides the employer's name, social security number if a sole proprietor, the general partner's name if a limited partnership, the employer's address, type of organization, date business started, date first wages were paid, if there is more than one business location, and the nature of the business.
Federal Income Tax Returns for Businesses
These schedules should be checked for expense items that could be wages.
Form 1040 - Attachments
- Schedule A itemizes allowable deductions against income; instead of filling out Schedule A, taxpayers may choose to take a standard deduction of between $5,700 and $15,800 (for tax year 2010), depending on age, filing status, and whether the taxpayer and/or spouse is blind.
- Schedule B enumerates interest and/or dividend income, and is required if either interest or dividends received during the tax year exceed $1,500 from all sources or if the filer had certain foreign accounts.
- Schedule C lists income and expenses related to self-employment, and is used by sole proprietors.
- Schedule D is used to describe capital gains and losses incurred during the tax year, and to calculate the tax amount due given the special reduced tax rates applied to capital gains and qualified (domestic) dividends.
- Schedule E is used to report income and expenses arising from the rental of real property, royalties, or from pass-through entities (like trusts, estates, partnerships, or S corporations).
- Schedule EIC is used to document a taxpayer's eligibility for the Earned Income Credit.
- Schedule F is used to report income and expenses related to farming.
- Schedule H is used to report taxes owed due to the employment of household help.
- Schedule J is used when averaging farm income over a period of three years.
- Schedule L is used to figure an increased standard deduction in certain cases.
- Schedule M (2009 and 2010) is used to claim the up to $400 "Making Work Pay" tax credit (6.2% earned income credit, up to $400).[3]
- Schedule R is used to calculate the Credit for the Elderly or the Disabled.
- Schedule SE is used to calculate the self-employment tax owed on income from self-employment (such as on a Schedule C or Schedule F, or in a partnership).
Form 1040 - Schedule C (Sole Proprietor Business Expenses)
The Form 1040 – Schedule C Profit or Loss from Business or Profession is completed by sole proprietors for each business they operate. Items of interest include wages, cost of goods sold, commissions, other deductions, and accounting method. This record shows the taxpayer name, address, social security number, business name, business address, and payments made.
Form 1040 – Schedule E (Supplemental Income and Loss)
Form 1040 – Schedule F (Profit and Loss from Farming)
The Form 1040 – Schedule C Profit or Loss, Schedule E Supplemental Income and Loss or Schedule F Profit and Loss from Farming, can be used by an LLC when the only member of the LLC is an individual. Items of interest include wages, cost of goods sold, commissions, other deductions, and accounting method. This record shows the taxpayer name, address, social security number, business name, business address, and payments made.
Form 1040 - Schedule H (Household Employee)
Form 1040 - Schedule H may be filed instead of the federal Form 940 Employer's Annual Federal Unemployment Tax (FUTA) report. Schedule H is an annual report of wages paid to domestic workers in an individual's home, and it also allows the individual to compute the amount of FUTA tax owed.
Form 1065 (Partnership Return of Income)
This form must be filed by every partnership receiving income from within the United States even if the principal place of business is outside the United States. Items of interest include wages, cost of goods sold, commissions, other deductions, Schedule K-1, and accounting method. This document also indicates names of partners, the business addresses, the FEID #, the date business was started. An LLC where there are multiple individuals listed as members will normal file a 1065, partnership income tax return.
Form 1120S (S Corporation Income Tax Return)
The Form 1120S U.S. Small Business Income Tax Return is completed by Subchapter S Corporations. Items of interest include wages, Schedule A - cost of goods sold, Schedule E - compensation of officers, Schedule K - distribution schedule.
Form 1120 (Corporate Income Tax Return)
Every corporation unless specifically exempt must file a tax return. Items of interest include wages, Schedule A - cost of goods sold, Schedule E - compensation of officers, Schedule L - balance sheets, dividend distributions. This document provides the employer's name, address, FEID #, date of incorporation and officers.
Form 990 (Organization Exempt from Income Tax)
Form 990 is submitted by tax-exempt organizations and non-profit organizations to provide the IRS with annual financial information. A short version, Form 990-EZ, may be used by organizations with gross receipts of between $25,000 and $500,000 and total assets of less than $2.5 million. (Organizations with gross receipts of under $25,000 in a year are not required to file a form 990). Form 990-PF, is available for private foundation organizations.
General Ledger
As a rule, transactions of a like nature are posted monthly into a set of accounts which serves the purpose of summarizing and balancing debits and credits recorded in the various journals and subsidiary records. Each account represents a classification that is used in reporting the financial and operating facts of the business. Asset accounts include cash, securities, inventory, equipment and depreciation. Liability accounts include accounts payable, notes payable, and taxes payable. Income accounts include sales and other income. Expense accounts include payroll expenses, commissions, contract labor, outside services, and other expenses.
General Journal
This is a book of original entry in a double-entry bookkeeping system that contains daily transactional entries. The general journal also contains correcting entries for erroneously recorded entries, and carries all entries not provided for by some special journal. Auditors should examine the general journal for items that may be wages but not included on the employer's tax report. Adjusting entries at or near the close of an accounting period should also be scrutinized for possible wage items.
Minute Book
This is a corporate record of directors' meetings. It may report changes in corporate officers, the salary for corporate officers, directors' fees, or the basis for dividends and stock bonuses. The Minute Book may also show compensation of employees and any noncash remuneration that may not be reflected in the bookkeeping records.
Notes Payable Ledger
If a note is given to an individual for services performed, investigate to see if it constitutes wages.
Notes Receivable Ledger
Shows money owed to the employer on a secured note. Notes may be repaid by performing services. The dollar amount being liquidated by the services would be wages, or it could be part of the wages paid for some services, with the balance being properly recorded.
Partners' Drawing Accounts
Payments to members of a partner's family are possibly charged against this account. If the payments are for services, they may constitute wages for the family member. The partnership tax return may be checked to see if these amounts have been shown as taxable income to a partner. Drawing accounts may also show payments made to individuals for personal services (i.e., baby-sitters or other domestic workers, etc.)
Partnership /Limited Partnership Agreement
A partnership agreement is useful in determining the partner/worker status of individuals. A formal agreement must be recorded with the Secretary of State for a limited partnership. These agreements may set out conditions of payment and employment of members of a partner's family.
Petty Cash or Cash Vouchers (SD)
Many small items such as postage, freight, and other small miscellaneous items are generally paid with petty cash. Normally, one individual handles the petty cash fund. Sometimes unreported wages are paid from petty cash, and therefore the activity in the petty cash fund should be examined by the Auditor. This is considered a source document for acknowledged payroll, hidden wages or unreported wages.
Profit and Loss (Income) Statement
A summary used at the end of an accounting period to determine if the business made a profit or loss during the accounting period. An examination of this record should give a total of salaries paid during the accounting period. It may also give information about the collectibility of taxes.
Stock Register
A corporate record that shows issuance and transfer of stock. The Auditor should check to determine if stock was given as payment for services. Since it shows the number of shares owned, it can be used to verify the proper payment of dividends.
Voucher Register
Expense item is set up until an invoice is paid. Services paid in cash may be found in the voucher register. Transactions may be traced back to the cash disbursement records. Alleged independent contractors may be included in the voucher register.

Last Revision: May 05, 2011

[ Audit System Manual- TOC ] [ Ch 1 - Introduction ] [ Ch 2 - Preparing for an Audit ] [ Ch 3 - Conducting the Audit ] [ Ch 4 - Completing the Audit Forms and Schedules ] [ Ch 5 - Audit System Screens ] [ Ch 6 - Miscellaneous ] [ Ch 7 - USDOL - Tax Performance System ] [ Ch 8 - Computer Fundamentals & Hardware ] [ Appendix ]
[ 3.1 - General Information ] [ 3.2 - Understanding the Payroll Flow ] [ 3.3 - Books and Records ] [ 3.4 - Employee vs Independent Contractor Decision ] [ 3.5 - Sample Audit Procedures] [3.6 - Minimum Audit Requirements of the TWC Tax Department & the Tax Performance System (TPS)] [3.7 - Post Audit Conference] [3.8 - Audit Report and Work Papers]
Chapter 3: Conducting the Audit	comments to: Tax Department

Chapter 3: Conducting the Audit

3.3 Books and Records

3.3.1 Records of Acknowledged Payroll

3.3.2 Other Books and Records