Cyclical Audits - T1 Transaction Flow-through Audit

Corporate Audit and Evaluation Branch
July 2006

• Executive Summary
• Introduction
• Focus of the Audit
• Methodology
• Findings
  • 1.0 Effectiveness of Source Systems as they Relate to the Accuracy and Appropriateness of Data Input and Processing
  • 2.0 Effectiveness of the RL System Processes as they Relate to the Accuracy and Appropriateness of the Data Captured in RL
  • 3.0 Flow-through Audit Methodology
• Conclusion
• Appendix A Components of the Cyclical Audit Plan For CRA's Administered Revenue
• Appendix B Summary of Audit Results

Executive summary

The Canada Revenue Agency (CRA) is the single largest government service provider in Canada. It interacts with over 29 million individuals, businesses, trusts, and organizations and collects more than $313 billion annually. This includes personal (T1) and trust (T3) income tax revenues[Footnote 1] totalling $93 billion federal and $35 billion provincial/territorial. Functional responsibility for ensuring the accurate inputting and processing of tax returns belongs to the Assessment and Benefit Services Branch (ABSB) while the Finance and Administration Branch (F&A) has functional responsibility for ensuring accurate accounting and reporting of these revenues.

At the request of F&A, the Internal Audit Division (IAD) of the Corporate Audit and Evaluation Branch (CAEB) developed a cyclical audit plan to support CRA in meeting these accounting and reporting responsibilities. The plan sets out a systematic approach to provide F&A, over time, with assurance on the accuracy of financial data relating to federal, provincial and territorial tax revenues and the adequacy of controls for detecting and preventing errors. The cyclical audit plan was presented to the Internal Audit and Program Evaluation Committee (IAPEC) and the CRA Board of Management (BoM) in 2005.

Under the cyclical plan substantive audit testing includes periodic transaction flow-through audits, which call for the tracing of assessment data from tax returns and related forms through to the Revenue Ledger (RL). These are to be carried out on all major revenue streams over a four-year period and T1 revenues (personal income tax) was chosen to be the pilot audit for the series.

Objective: The objective of the T1 Transaction Flow-through audit was to provide assurance with respect to the accuracy and appropriateness of the flow of personal tax information through CRA's automated systems, from the source documents through the assessing and tax payer accounting systems to CRA's corporate accounting system, the RL. In addition, as a pilot it provided an opportunity to look at different audit methodologies and assist F&A in developing their own Financial Monitoring Framework for T1 revenues.

Conclusion: The results of the audit indicate that tax information flowed accurately and appropriately through CRA's automated systems, from the T1 return line items used on the source documents for the selected returns through to the RL accounts. The sample size was relatively small but sufficient to trace and verify the flow of data though 75 of 97 potential assessing lines in the T1 mainframe systems and the posting of the same information to the RL accounts for 78 different federal, provincial and territorial taxes. Overall, no differences were detected between the tax information processed in the assessing and accounting systems and the information posted to RL.

The usefulness and results of the various methodologies tried in selecting sample T1 General returns for review were shared with and have been made use of by F&A in the implementation of an ongoing monitoring framework for the T1 revenue stream.

Future T1 flow-through audits will consider risks to data flow resulting from any new releases of the T1 system, changes made to the tax forms, changes made to the mapping/ allocation of amounts to RL accounts and the manual assessing system.

Introduction

The Canada Revenue Agency (CRA) is the single largest government service provider in Canada. It interacts with over 29 million individuals, businesses, trusts, and organizations and collects more than $313 billion annually. This includes personal (T1) and trust (T3) income tax revenues[Footnote 2] totalling $93 billion federal and $35 billion provincial/territorial. Functional responsibility for ensuring the accurate inputting and processing of tax returns and assessments belongs to the Assessment and Benefit Services Branch (ABSB) of CRA while the Finance and Administration Branch (F&A) has functional responsibility for ensuring accurate accounting and reporting of these revenues.

At the request of F&A, the Internal Audit Division (IAD) of the Corporate Audit and Evaluation Branch (CAEB) developed a cyclical audit plan to support CRA in meeting these accounting and reporting responsibilities. The plan sets out a systematic approach to provide F&A, over time, with assurance on the accuracy of CRA financial data relating to federal, provincial and territorial tax revenues and the adequacy of controls for detecting and preventing errors. The cyclical audit plan was presented to the Internal Audit and Program Evaluation Committee (IAPEC) and the CRA Board of Management (BoM) in 2005. Key components of the plan are briefly described in Appendix A.

Audit efforts are initially focused on substantive testing but will ultimately move towards more controls-based work. IAD already conducts substantive testing on a regular basis at fiscal year-end to confirm the accuracy of elements of the CRA financial statements such as cash receipts and accounts receivable. Under the plan this work will continue but substantive testing was expanded to include periodic transaction flow-through Audits. Flow-through audits call for the tracing of assessment data from tax returns and related forms through to the Revenue Ledger (RL). These are to be carried out on all major revenue streams over a four-year period and T1 revenues (personal income tax) was chosen to be the pilot audit for the series.

Focus of the Audit

The objective of the T1 Transaction Flow-through audit was to provide assurance with respect to the accuracy and appropriateness of the flow of personal tax information through CRA's automated systems, from the source documents through the assessing and taxpayer accounting systems to CRA's corporate accounting system, the RL. In addition, as a pilot it would provide an opportunity to look at different audit methodologies and assist F&A in developing their own Financial Monitoring Framework for revenues.

Methodology

The audit was performed in two phases between January and September 2005. In the first phase, a limited number of T1 General Returns (20) for tax year 2003 were randomly selected to test the audit methodology and provide a preliminary assessment of the auditability of the flow of the T1 revenue stream. For the second phase, an additional 48 returns were selected as samples from tax year 2004 to increase coverage of the kinds of revenue that could be reported on the T1 General return. This phase also included a visit to a Tax Centre (TC) to observe the processing of hard-copy T1 tax returns.

The extent to which results from this audit can be projected to form conclusions about T1 processing as a whole is limited by the relatively small sample size and judgement sampling method that was used in selecting the T1 returns for review. However, it is a viable approach to use in checking and providing assurance on the accuracy and completeness of data flowing through automated systems as all items are subject to the same system logic and predefined business rules.

For the samples selected that had been filed on a paper tax return, IAD obtained the tax return filed by the taxpayer and considered the reasonableness and accuracy of the assessment by performing a recalculation of the tax assessment. The calculated values were then compared to the amounts recorded in the T1 assessment system. (For samples that were filed by electronic means the review commenced with the information received by the T1 assessment system). T1 assessment values were compared to the assessment results captured in the T1 Accounting sub-system and then traced to the RL and compared to the calculated amounts to verify accuracy and completeness. The suitability of the revenue and credit accounts against which the federal, provincial and territorial tax amounts were recorded in the RL was also confirmed.

Findings

1.0 Effectiveness of Source Systems as they Relate to the Accuracy and Appropriateness of Data Input and Processing

For all T1 returns sampled from tax years 2003 and 2004, the amounts examined were found to have been accurately and appropriately processed by the source system. Differences noted between taxpayer return and assessed information were caused by the assessing system rounding or picking up errors made by the taxpayers. Results of the sample review are outlined below and a more detailed summary of audit testing is provided in Appendix B.

1.1 Processing of Assessments

The T1 assessing system for processing personal income tax returns is mainframe based and has several different components or sub-systems through which data is captured and through which it flows. The principal components are the Daily Assessing System (DAS/TAD), the T1 Assessment and T1 Accounting sub-systems. T1 tax information is accessed through the use of a national mainframe menu system known as RAPID (Rapid Information for District Offices) that acts as an interface for 42 options and numerous sub-options.

Complex returns where the entire assessment needs to be done manually are processed separately in the Automated Assessment Control System (AAC), which passes on the assessment data to the RL. The data flow through AAC was not examined as part of this initial audit of T1 information because of the manual intervention in their processing.

Payments made directly by the taxpayer or on their behalf by an employer (source deductions) are input and processed through the CRA Financial Input Processing (FIP) system. This information is then forwarded to other CRA systems including the T1 Accounting Payments (TAP) sub-system, Information Declaration System (INFODEC) and the RL. Remittance slips and information included with the sample taxpayer returns was verified against the payment information in these three systems.

1.2 Processing of Remittances and Disbursements

The flow of T1 tax instalment payments was verified in T1 taxpayer accounting and in the appropriate account in the RL. It was however, only possible to trace the payments from the T1 RL instalment account to the RL clearing account. The remittances recorded in RL by FIP as payments could not be traced to the individual originating cash entries because these were batched for processing. The same occurs with T1 refunds and this batching of payments and disbursements reduces the audit trail within RL. Instead, a review of the source documents would be necessary in order to completely validate the existence, accuracy and proper assignment of a payment or disbursement.

1.3 Postings to Taxpayer Accounting

For all T1 returns sampled from tax years 2003 and 2004, payments and disbursements and postings to taxpayer accounts were found to have been accurately and appropriately processed and accounted for by the source system. Any differences found between the assessed amounts and the amounts on the taxpayer accounting during the review were not material and were caused by the accounting system reporting changes to the taxpayer's final balance (such as interest calculations on balances or refund amounts being held for outstanding balances).

2.0 Effectiveness of the RL System Processes as they Relate to the Accuracy and Appropriateness of the Data Posted in RL

Overall, no differences were detected between the tax information processed in the assessing and accounting systems and the tax information that was posted to RL.

2.1 Posting to the RL

Two inconsistencies were noted in the manner in which values had been posted to the RL from the T1 assessing system. First, when an initial assessment (IAS) results in a balance owing, the entire amount owing posts to RL as a debit to accounts receivable (A/R). Any amount paid on filing is then applied against the A/R as a credit. An IAS, however, does not always post to the T1 A/R account in RL. When an IAS results in a refund no amount is posted to A/R; instead, the refundable amount goes directly to the clearing account in RL and bypasses the A/R account. This inconsistency may become a factor when there are difficulties clearing accounts or reconciling and determining amounts for A/R.

Inconsistencies also exist in the posting of reassessments to RL. When a reassessment is processed, the originally assessed federal and provincial tax revenue or credit amounts that are being reassessed are reversed in the RL. The new values for the reassessment are also posted at this time in the same journal entry as the reversals. On the other hand, when a reassessment changes the amount of a taxpayer's tax deductions at source there is no reversal of the previous value; the amount that posts to RL is only the change in dollar value. Using a single method to post reassessments to the RL would lead to a more consistent approach to posting that would reduce the complexity of the posted transaction. Using a single posting method would ensure consistency and reduce difficulties in reconciling and facilitate the monitoring of the effectiveness of the RL.

2.2 Audit Trails

When examining assessment data in the RL it is not possible to determine the TC that processed a T1 assessment. In the table that details the information that is needed in the data file being sent to RL for T1 assessments, the originating TC is not a required field. As a result, this information is not being sent to RL. The ability to easily determine the originating TC in RL would improve the audit trail of the transaction and improve the ability to monitor the effectiveness of the RL.

3.0 Flow-through Audit Methodology

A secondary objective of the audit was to identify and test sampling methodologies that might be suitable and could be replicated in other flow through audits as well as be used by F&A in developing an approach for their own Financial Monitoring Framework for revenues.

In the first phase of the audit, a limited number of T1 returns (20) were randomly selected from tax year 2003 to provide a preliminary assessment of the auditability of the T1 revenue stream and test the audit methodology. For the second phase a judgement or targeting method was used to select an additional 48 samples from tax year 2004 to expand the audit coverage of the T1 line items. Overall, the flow of data from all of the samples that were selected for review were traced and verified from the T1 General Returns though to 75 of 97 possible assessing line items in the T1 mainframe systems and RL revenue and liability accounts for 78 different federal, provincial and territorial taxes. (See Annex B for listing of RL accounts.)

Two different approaches were used in the targeting of samples. The first involved drawing random samples from RL accounts populated by tax forms that had undergone the most significant changes from tax year 2003 to tax year 2004. The objective was to mitigate the risk associated with changes to the tax forms by verifying that the data was still accurately flowing through the assessing system and populating the appropriate RL accounts after the changes had occurred. The second testing method called for targeted sampling of returns randomly selected from a single TC in order to increase coverage of RL accounts for specific provinces and territories.

The final method tried was verifying transaction data electronically by matching a system download of T1 assessing data to a system download of RL data. The feasibility for electronic matching of large revenue files was confirmed as a viable option for use in future audits.

Conclusion

The results of the audit indicate that tax information flowed accurately and appropriately through CRA's automated systems, from the T1 return line items used on the source documents of the selected returns through to the RL accounts. The sample size was relatively small but sufficient to trace and verify the flow of data though 75 of 97 potential assessing lines in the T1 mainframe systems and the posting of the same information to the RL accounts for 78 different federal, provincial and territorial taxes. Overall, no differences were detected between the tax information processed in the assessing and accounting systems and the information posted to RL.

The usefulness and results of the various methodologies tried in selecting sample T1 General returns for review were shared with and have been made use of by F&A in the implementation of an ongoing monitoring framework for the T1 revenue stream.

Future T1 flow-through audits will consider risks to data flow resulting from any new releases of the T1 system, changes made to the tax forms, changes made to the mapping/ allocation of amounts to RL accounts and the manual assessing system.

Appendix A Components of the Cyclical Audit Plan For CRA's Administered Revenue

Control Framework Assessment - IAD will provide input and support to F&A and its partners (ITB and ABSB) in the development and assessment of a control framework. The overall objective of the F&A project is to develop assurance that adequate controls over revenue assessment and reporting exist, operate as intended, and can be relied upon. Currently, F&A is focussing on controls over provincial tax revenues and credits in preparation for a controls audit by the Office of the Auditor General (OAG).

Controls Testing - Primarily the testing of controls will be accomplished through Accrual Accounting Audits. IAD will perform a series of audits with the objective of assessing whether adequate financial controls are in place and reasonable accrual accounting methodology exists to support the preparation of accurate financial statements. The audits will review controls over such things as timeliness, accuracy, and completeness of the processing of receipts and assessment details by the source systems and Revenue Ledger. They will also consider the reasonableness and completeness of the accrual accounting methodology and compliance with Treasury Board Secretariat requirements.

Substantive Testing - IAD substantive testing work has historically focussed on the potential risk areas in CRA financial reporting as identified by F&A and the Office of the Auditor General (OAG). Under the plan the other significant component of substantive testing will be a series of Transaction Flow-Through Audits. These audits will trace data processing from source documents to the Revenue Ledger (RL), examining the amounts for accuracy and allocation to the appropriate RL accounts. The audits will cycle through all of CRAs different revenue types over the next four years.

Monitoring Framework Support - IAD will support F&A in the development of a monitoring framework for revenues. IAD will also share knowledge and any tools it develops as part of its cyclical audit work. The T1 Transaction Flow-through sampling methodology, for example, was used by F&A in developing its own sampling model for the monitoring work they are performing in the regions.

Appendix B Summary of Audit Results

T1 Revenue Source Documents

• T1 General Returns and schedules for tax years 2003 and 2004 (electronic and hard copy).
• Taxpayer payment and income remittance slips (T4, T5, etc.).

Processing Systems

• T1 Daily Assessing System (DAS/TAD) - processes T1 assessments and reassessments and posts the results to an individual's account. DAS updates the details of the assessment or reassessment to the assessing master and updates a summary of the assessment or reassessment on the accounting master .
• T1 Accounting Payments System (TAP) - receives payments intended for T1 accounts from FIP and processes these payments to an individual's accounting master.
• Rapid Information for District Offices System (RAPID) - national mainframe menu system used as a means of accessing T1 and T2 mainframe systems. RAPID acts as an ""interface" with 42 options and numerous sub-options.
• Information Declaration System (INFODEC) Display Menu - used to view employer and financial institution remittance information.
• Financial Input Processing (FIP) - records payments (cash receipts) received from or on behalf of taxpayers (all methods of payment).
• Revenue Ledger (RL) - consolidated general ledger system for financial transactions relating to administered revenues.

Audit Methodology

• 68 T1 tax returns and assessments were selected for review from tax years 2003 and 2004. Twenty of these samples were selected randomly and 48 were selected using a judgement or targeting approach in order to provide broader coverage of revenues for provinces/territories.
• T1 tax data was examined from the source documents through CRA's T1assessing & accounting system/sub-systems through to the RL.
• The extent to which results can be projected to form conclusions about T1 processing as a whole is limited by the relatively small sample size and judgement sampling method that was used in selecting the T1 returns for review. However, it is a viable approach to use in checking and providing assurance on the accuracy and completeness of data flowing through automated systems as all items are subject to the same system logic and predefined business rules.

Results - Summary

Federal & Provincial RL Revenue & Liability Accounts Traced from T1 Returns

Footnotes

[Footnote 1]

Personal (T1) and Trust (T3) tax revenues are reported together as a single amount in CRA financial statements. For purposes of this audit only the flow of T1 tax information was examined.

[Footnote 2]

Personal (T1) and Trust (T3) tax revenues are reported together as a single amount in CRA financial statements. For purposes of this audit only the flow of T1 tax information was examined.