Introduction
Individuals and businesses should give a full disclosure of income in the financial statements. Unreported revenue comprises of certain income on the tax return of taxpayers that they fail to report with an aim of avoiding tax. There are a number of ways that can be used to discover unreported revenue. They include bank deposit method, net worth method, source and application of funds method, lifestyle audit, third party contacts, and mark up analysis among others. The paper identifies unreported income for Mr. Jung. It uses the net worth method, sources and application of funds method, and bank deposit method. It also talks about the reasonableness of the estimates and the weaknesses of the three methods used for estimation.
Net worth method
The difference between assets and liabilities for a definite period gives the net worth for Mr. Jung. The value obtained is compared with the net worth for prior years. Unjustified rate of increase of net worth for different periods gives indications for unreported income. In this approach, the net worth of the client at the beginning and end of the period should be computed accurately. The increase in net worth that cannot be accounted for shows unreported income.
Calculation of unreported income
Total assets
Total liabilities
Unreported income
Explanation
From the table, unreported income amounted to $28,500. It implies that the changes in net worth in the two years could not be justified. The results obtained are not reasonable. They may not be relied on due to a number of weaknesses such as failure to keep money in financial institutions and the inability to obtain records for expenses. These two depends on the customer’s willingness to disclose required information. In addition, it might not be possible to identify personal assets bought during the year.
Sources and application of funds method
The method compares expenses and income of the client. Undisclosed income is the excess of uses over sources.
Calculation of unreported income
Known sources of funds
Unreported income
Explanation
From the table, revenues exceed expenses. It means that Mr. Jung does not have unreported income. However, the estimates are not reasonable. For instance, the net cash deposits in the bank ($322,000) exceed known sources of funds ($307,000). The difference shows the unreasonableness of the estimates. The approach has a number of weaknesses such as, unreported income may result from overstating expenses or understating revenue. Also, the method assumes that the customer will disclose all his spending. These assumptions reduce the effectiveness of the method.
Bank deposit method
Bank deposit method compares bank deposits and credit of the customer. Adjustments are made to eliminate transfers between banks and non income deposits.
Calculation of unreported income
Unreported income
Explanation
From the calculations, unreported income amounts to $187,000. The result is reasonable since the method captures all the financial activities of the customer. The method assumes that the customer banks all revenues. Also, the method cannot be relied on when the client records are inadequate, do not exist or show possibility of manipulation.
Conclusion
The paper identifies the presence of unreported income for Mr. Jung using three methods. The results of computations show that there is existence of unreported income. The three methods are not effective though they give an indication of the existence of unreported income. Besides, they provide information about the client such as frequency of income, sources of funds, and ways in which the customer spend his earnings. An investigator should use effective approaches such as unit and volume method and mark up method to determine unreported income.