This discussion applies to the audit of full or part time business income. Other audits are for Payroll or Goods & Services Tax. After the Canada Revenue Agency (CRA) select a tax payer for audit for one or more returns, they usually write a letter listing the papers, also called books, they need to examine. An audit of a return is initiated usually one to three years after its filing. Books usually include Source Documents (SD), e.g. bills, invoices, bank statements; Journals and Ledgers (JAL) and Working Papers—this includes mainly Year End Adjustment (YEA) schedules. Sometimes CRA asks you to complete a questionnaire before asking for the papers.
If your books are not prepared properly, you (or your representative if they are prepared to defend you even without proper books) meet with the auditor with all the books. For an audit, one item (also called account) is taken at a time, e.g. purchase of goods or office expenses. The auditor first asks for the breakdown of the item amount. If they are not convinced by the breakdown or you simply did not have one, they ask you to show cancelled checks, for the proof of payments represented in the amount. They then ask for bills and receipts (BR) for the proof and details of purchases, expenses, or revenue relating the item. If you are unable to show the pertinent papers immediately, the examination takes more time and meetings. The auditor then repeats the process for other items. If some amounts are partially substantiated, they change the amounts to correspond to the evidence. This usually increases revenues or decreases expenses thus increasing your taxes. They then apply penalty and interest on the additional tax and write you a letter about their findings and the additional charges. A few weeks later, you receive a Notice of Re-assessment confirming all the charges.
If your books, SDs, JALs and YEA schedules were prepared properly, you—or in this case most likely your representative—provides the auditor pertinent papers in a short meeting explaining how they are organized. The computer printed ledger shows a breakdown of each item amount. It also shows where the bill/receipt for each ledger transaction is located in the papers. Since BRs are quickly accessible, the examination takes much less time. After examination, they call you and ask some questions. You may provide answers on phone, through correspondence or a brief meeting. They then change the amounts to reflect your answers and their findings and follow the remaining procedure discussed above. With proper books, you would end up paying much less additional charges and in some cases you may even receive a refund, i.e. part of taxes paid previously.