REPUBLIC OF THE PHILIPPINES

DEPARTMENT OF FINANCE
BUREAU OF INTERNAL REVENUE

February 17, 2003

REVENUE MEMORANDUM ORDER NO. 3-2003

SUBJECT: Prescribing Guidelines and Procedures in the Conduct of Inventory

Taking/Stocktaking and Verification of Inventories Covering Taxable Year
2002 by the Large Taxpayers Audit and Investigation Division I, Large
Taxpayers Audit and Investigation Division II, Large Taxpayers District
Office – Makati, Large Taxpayers District Office - Cebu and Revenue
District Offices

TO : All Internal Revenue Officers and Others Concerned

I. BACKGROUND

Under Section 6 (C) of the National Internal Revenue Code, as amended,

the Bureau is empowered to conduct inventory-taking of goods of any taxpayer
for purposes of determining his correct internal revenue tax liabilities, or it may
place the business operations of any person under observation or surveillance, if
there is reason to believe that such person is not declaring his correct income,
sales or receipts for internal revenue tax purposes. While this power is inherently
provided in the Tax Code, it has been observed that this tool has not been fully
utilized by the Bureau to enhance taxpayer’s compliance.

Over the years, the decline in reported sales and purchases of certain
establishments resulted to substantial reduction in tax collections; and this
unfavorable trend in financial reporting could also be attributable to erroneous
reporting in the year-end inventory lists. Since inventories are major components
in determining cost of goods sold, any inaccurate reporting of this account in the
inventory lists and financial statements will result to distortion of taxable income.
Accordingly, verification of inventories of taxpayers in relation to purchases and
cost of sales must be pursued vigorously and the same must be conducted with
regularity.

II. OBJECTIVES

1. To determine through the inventory verification method if taxpayers have

declared the correct amount of sales and paid the corresponding internal
revenue taxes;

2. To prescribe uniform guidelines and procedures for a comprehensive and

effective verification of inventories, inventory lists, and inventory records as
well as prescribe reporting requirements as a result thereof;
 3. To monitor taxpayers’ compliance with the registration of their warehouses,
storage places and bodegas together with their books of inventories as
provided under Revenue Regulations No. 5-94; and

4. To gather data through the inventory verification method in relation to the

investigation of income tax, value-added tax, and other internal revenue tax
liabilities of taxpayers.

III. SCOPE

This Order prescribes inventory-taking and verification of all inventories

and inventory records of finished goods, work in process, raw materials, supplies
and stock-in-trade as of the date of stocktaking and all inventory lists covering
taxable year 2002 filed by taxpayers, except that for taxpayers subject to excise
tax, a supplemental Revenue Memorandum Order shall still be issued.

IV. POLICIES

1. The verification of inventories under this Order shall be undertaken by the

Large Taxpayers Audit and Investigation Division (LTAID), Large Taxpayers
District Office (LTDO) – Makati, Large Taxpayers District Office (LTDO) –
Cebu and Revenue District Offices (RDO) having jurisdiction over the
taxpayers selected for stocktaking/inventory verification.

Where a taxpayer selected for stocktaking has multiple branches, warehouses,

bodegas, or facilities, simultaneous conduct of inventory taking/stocktaking
shall be made on these premises to determine the correct total stocks on hand
by the taxpayer. The inventory-taking activity shall be conducted by the
LTAID/LTDO/RDO having jurisdiction over the taxpayer’s head office.

2. Inventory verification shall be authorized through a Mission Order (MO) (BIR

Form 0422) (Annex “A”) and a letter to the taxpayer (Annex “B”) duly signed
by the Assistant Commissioner, Large Taxpayers Service (ACIR,
LTS)/concerned Regional Director.

3. Revenue Officers (ROs) from the Assessment Group shall be authorized to

conduct verification of inventories. However, the chief of the investigating
office may assign ROs from the Collection and Document Processing Sections
to assist in the verification of inventories.

4. The physical inventory-taking of stocks on hand as of the period covered by

the stocktaking shall be conducted by four (4) ROs at the minimum with at
least one (1) RO from the Assessment Group. The physical counting of stocks
on hand shall be undertaken immediately upon service of the Mission Order
without any prior arrangement with the taxpayer to verify the physical

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 existence of the stocks actually on hand as of the time of
stocktaking/inventory-taking.

5. In determining the pending inventory verification workload, each Mission

Order is counted as one case of each and every RO assigned to the case.

6. In case the taxpayer subjected to inventory verification agrees to the findings

resulting to corresponding adjustments to sales or cost of sales, the following
courses of action shall be undertaken by the Revenue Officer:

6.1 Require the taxpayer to pay resulting deficiency taxes upon conclusion
of the inventory-taking activity, without prejudice to the issuance of a
Letter of Authority upon recommendation of the ACIR, LTS/Regional
Director and approval of the Commissioner.

6.2 Record the findings discovered in the course of verification for reference
in any subsequent audit of the concerned taxpayers subjected to
stocktaking.

7. The Revenue Officers shall prepare a report of inventory

verification/stocktaking within thirty (30) days after service of the Mission
Order and letter to the taxpayer stating the inventory verification, unless an
extended period is allowed by the Commissioner. In the event that no report
is forthcoming, the revenue officers shall explain in writing why a report
thereon could not be submitted. If the failure to render a report is due to the
refusal of the taxpayer to provide the necessary information relative to the
correct determination of inventory valuation, the corresponding
recommendation for the issuance of Subpoena Duces Tecum shall be made
under existing rules and regulations.

8. The Chief, LTAID/Chief, LTDO/Revenue District Officer shall transmit the

dockets of the case together with the reports of inventory
verification/stocktaking to the Review and Evaluation Group, LTS/Chief,
Assessment Division for appropriate review prior to final review and approval
by the ACIR, LTS/concerned Regional Director within ten (10) days from
submission by the inventory team.

9. The list of candidates/taxpayers to be the subject of stocktaking, with mention

of reasons for the selection of the candidates, shall be approved by the
Commissioner before the start of the actual inventory-taking activity.
(Figures and computation should be part of the list, if necessary.)

V. GUIDELINES AND PROCEDURES

1. The Chief, LTAID/Chief, LTDO/Revenue District Officer shall draw up a list

of taxpayers selected for the conduct of inventory-taking/stocktaking stating
the justification for his selection, such as where there is reason to believe that
such taxpayer is not declaring his correct income, sales, or receipts for

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 internal revenue tax purposes. The taxpayer may be selected for inventory-
taking if he falls under any of the following cases:

1.1 Taxpayers with no VAT payable/with excess input tax over output tax in
all the quarterly VAT returns during the taxable year

1.2 Taxpayers maintaining an ending inventory of 100% or more of its gross

sales during the taxable year as per example below:

Ending Inventory P 5,000,000.00

Gross Sales = P 5,000,000.00 = 100%

1.3 Taxpayers who were apprehended for violations of certain internal

revenue laws and regulations as a result of surveillance pursuant to
Revenue Memorandum Order No. 54-2000.

1.4 Taxpayers who were apprehended for violations relating to non-issuance

of invoices.

2. The lists of taxpayers selected for stocktaking shall be recommended by the

Chief, LTAID/Chief, LTDO/Revenue District Officer, through the ACIR,
LTS/Regional Director, for approval of the Commissioner using the format
prescribed in Annex “ C” hereof. The ACIR, LTS/Regional Director shall
furnish the Deputy Commissioner, Operations Group and Assistant
Commissioner, Assessment Service with a copy of the said approved lists
within three (3) days from approval thereof.

3. The Chief, LTAID/Chief, LTDO/Revenue District Officer shall prepare the

MOs and letters addressed to the taxpayer for signature of the ACIR,
LTS/Regional Director to be distributed as follows:

Distribution of MO:

Original - to the Revenue Officers assigned to conduct

the stocktaking/inventory verification

Duplicate - to be furnished to the taxpayer (Subject of

the Mission Order)

Triplicate - to be duly acknowledged by the taxpayer or

his authorized representative. This serves
as a file copy of the Office conducting
the inventory verification. (A photocopy
thereof shall be attached to the report.)

Quadruplicate - file copy of the Assessment Service

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 Distribution of letter addressed to subject taxpayer:

Original - to be furnished to the taxpayer together with

the duplicate copy of the MO

Duplicate - to be attached to the report/docket

Triplicate - file copy of the Assessment Service

All MOs issued shall be recorded sequentially in the Mission Order Register.
Blank MOs to be issued under this Order shall be requisitioned by the ACIR,
LTS/Regional Director from the Accountable Forms Division.

4. Prior to the service of the Mission Order to the taxpayer, the Revenue Officer
shall secure the following data from the ITS records or from any available
records within the Bureau:

4.1 Inventory of all printed accountable forms covered by permits issued by

the Bureau (e.g. sales invoices, official receipts, delivery receipts, etc.);

4.2 All books of accounts and other accounting records registered with the
investigating office/RDO (e.g. general ledger, general journal, sales
books, purchase books, subsidiary sales and purchase books, etc); and

4.3 Registration data of all branches, warehouses, bodegas, or facilities

maintained including their corresponding addresses;

4.4 Annual inventory list filed with the BIR for the immediately preceding
year to establish the beginning inventory for the taxable year covered by
the inventory verification.

5. After serving the Mission Order, the RO/s shall perform immediately the
following inventory verification procedures:

5.1 Familiarize with the taxpayer’s business and its products. Interview the
taxpayer and other knowledgeable personnel of the company and
conduct a tour of the business premises. Discuss the cost components,
inventory pricing system adopted including the procedures for ordering,
receiving, recording and issuing stocks or inventories.

5.2 Request/secure from the taxpayer copies of the following:

a. List of all inventory items;

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 b. Records of sales, purchases, sales returns, purchase returns and other
records/documents, such as stock cards, pertinent to the taxpayer’s
records of inventories; and

c. Inventory lists at the end of the year based on inventories segregated

per location where the same are stored or maintained.

5.3 Conduct immediate physical count of all accountable forms and

establish cut-off thereof.

a. Control the taxpayer’s inventory records or stock cards, accountable

forms and inventory books during the time of inventory test to
preclude any alterations thereof.

b. Account for all issued and unissued accountable forms and note any
break in their pre-printed series. Require the taxpayer to
explain/justify reasons therefor.

c. Sign the duplicate/file copy of the last sales invoice/delivery receipt/

sales return document issued indicating the date and time thereon.

d. Mark the Sales Book to identify the last recorded invoice used on the
day before the conduct of stocktaking. The same shall also be done on
the Purchase Book to tag the last recorded inventory receipt of the
previous day. Marking of the books or records may be made by
drawing two straight lines under the last transaction entry, and affixing
the signature of the concerned ROs, with the date of the start of the
physical count. The marking of the books must be done to establish
proper inventory cut-off.

e. Request for the stock ledgers/books of inventories, if maintained by

the taxpayer, and proceed to the warehouses, storage places, bodegas,
facilities, and other premises where inventories are being stored,
maintained or displayed for sale. Require the taxpayer to segregate
consigned goods, “inter-company” stocks, obsolete items, and other
items not properly includible in inventories and to submit documentary
proofs to validate the segregation of such items.

Depending on the taxpayer’s treatment of inter-company transfers of

inventories (whether or not the title to the goods were transferred
among the different units of the taxpayer), these items should
generally not be disregarded since not all inter-company transfers are
excluded in inventories.

5.4 From the list of inventory items, select a representative sample of at

least 10% of the total number of inventory items.

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5.5 Determine fast-moving items and slow-moving items in the inventory
that can be feasibly counted based on the stock cards. Prioritize the
counting of the fast-moving stocks over the slow-moving items in the
inventory.

5.6 Prepare pre-numbered inventory count tags or any other medium in

duplicate indicating the name of the inventory item, stock number,
plant/warehouse location and count measurement. The duplicate of the
tags should be attached to the goods until the inventory summary is
completed while the original tags should be kept together with the
summary sheets. Inventory compilation sheets should also be prepared
so that the data recorded on tags or count media can be transferred,
priced, extended and totaled.

5.7 Conduct a full or detailed physical inventory count in the presence of the
taxpayer or his authorized representative. Put duplicate count tags on
the items counted. Ensure that the quantities and units of measurement
(i.e., pieces, boxes, dozens, drums, etc.) on the tags and inventory sheets
are stated in the same unit used by the taxpayer in his record of
transactions and on the inventory records/stock cards.

5.8 Record counted items on the Inventory Count Worksheet (Annex “D”).
Ensure that the tags/cards, count sheets and final summaries have been
signed/initialed by the concerned ROs who did the physical count and
countersigned by the taxpayer’s representative(s) on the date of the
stocktaking.

5.9 Ascertain the level of internal control relative to the processing/handling

of inventories adopted by the taxpayer. In case the internal control is
weak and substantial discrepancies were noted during the initial
inventory verification, a full or detailed inventory count of all the items
must be made.

5.10 Verify the method of inventory valuation adopted by the taxpayer and
ascertain if it conforms to the acceptable valuation methods prescribed
under the Tax Code, as implemented by Sections 145-151 of Revenue
Regulations No. 2.

5.11 Check if all books of inventories are registered with the BIR pursuant to
Sec. 13 of the Bookkeeping Regulations, as amended by the Revenue
Regulations No. 5-94. Match with the registration data of books of
accounts secured from ITS or other sources within the Bureau.

5.12 Reconcile Actual Inventory Summaries with Inventory Records/Stock

Cards kept by the taxpayer.

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a. Verify the extensions, footings, and totals on inventory sheets.
Quantities and unit prices must be stated in correct units (e.g.,
dozens and price per dozen; tons and price per ton, etc.).

b. Compare the result of the actual physical count with the balance on
taxpayer’s inventory lists and stock cards. Perform the following
procedures in case of existence of discrepancies:

b.1 Secure copies of all Purchase Orders, Receiving Records,

Related Invoices, Debit Memoranda for returned items, and
verify the accounting entries from the beginning of the taxable
year (or the end of the period covered by the inventory list) to
the date of stocktaking.

b.2 Check all sales and purchases transactions of the same items
starting January 1 (or the first working day of January) or the
beginning of the fiscal period, as the case may be, up to the date
of the test verification or stocktaking.

b.3 Verify the series of the sales invoices issued and recorded during
the period and account for any break in the series. Be alert on
the possibility that the unaccounted series of sales invoices may
indicate unrecorded sales.

b.4 Perform work-back procedures to determine actual inventory

quantities and peso values at year-end. Reconcile inventory
lists submitted with the result of the work-back procedures.
Inquire and investigate reasons for discrepancies noted.

b.5 Secure third-party information on sales, purchases, and import

transactions from internal and external sources, in accordance
with the provisions of existing rules and issuances.

b.6 Ascertain the tax implication of confirmed third-party data or

information that were not taken up or reflected in the taxpayer’s
inventory records. For this purpose, illustrative examples of tax
implications of some possible discrepancy scenarios are shown
in Annex “E” hereof.

b.7 Ascertain the sales in quantity of items verified from the

duplicate copies of sales invoices, delivery receipts, and sales
book/general journal (for transfers not covered by sales/delivery
invoices) and compare the quantity with the quantity sold per
investigation. Any discrepancy may indicate undeclared sales.

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 b.8 Ascertain the actual quantity of goods purchased or received
from the original copies of purchase invoices, importation
documents, copies of receiving reports or similar documents,
purchase books, and general journals. Compare the same with
the quantity of goods received/handled per investigation. Any
discrepancy thereon may indicate undeclared sales or
overstatement of costs.

b.9 Deduct the quantity on hand of the test-checked items from the
quantity available for sale (Inventory Beginning plus Purchases,
net of purchase returns). The difference in quantity should
represent the quantity sold from January 1 (or the first working
day of January) or the beginning of the fiscal period, as the case
maybe, up to the time of physical count or stocktaking. Trace
difference in quantity sold from the accounting records relative
to credit transactions on the inventory account such as sales
invoices, delivery receipts, and credit memoranda for returned
sale items. Any discrepancy in quantity should be verified. If
the taxpayer cannot justify the same, these may represent
undeclared sale of the same item or inventory.

b.10 Account for any over/understatement of inventory by applying

the following pro-forma analysis:

COMPUTATION OF OVER/UNDERSTATEMENT OF INVENTORY

As of December 31, 200__
Count Date ____________

Ending Inventory per Inventory List/Audited F/S P XXX

Inventory of Goods per Physical Count P XXX
(Refer to Inventory Count Sheet)
Add (Deduct) Adjustments:*
Disposal of items/goods evidenced by Sales Invoices XXX
Withdrawal of goods evidenced by materials
issuance slip/delivery receipts XXX
Receipt of items/goods evidenced by materials
receiving report/delivery receipts (XXX)
Other receipt of goods evidenced by materials
receiving report/delivery receipts (XXX)
Importation of goods evidenced by importation
documents (XXX)
Adjusted Inventory of Goods per Physical Count As of
December 31, 200__ XXX
Difference Over/(Under) XXX

• Pertains to movement of items/goods from cut-off date to inventory count date.

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 5.13 Compute for the value of the undeclared sales by multiplying the
discrepancy in quantity by the unit selling price of the test-checked item.
In the event that there were increases in the selling prices of goods,
specific identification of selling prices of affected goods must be made
in computing the undeclared sales.

5.14 If the taxpayer does not maintain inventory records/books or stock

cards, the Revenue Officer shall determine the discrepancy by using the
beginning Inventory List as submitted by the taxpayer. From the
beginning balance, add all items of purchases with adjustments on
returned items and materials/goods in transit, to arrive at the total items
for sale. From this quantity, deduct all the items sold with adjustments
on returns, to get the number of items as ending inventory. Match the
resultant figure per item of inventory with the quantities reflected in the
physical inventory count and verify discrepancies, if any. If the
taxpayer cannot validly justify the discrepancy( ies) noted, consider the
same as undeclared sales.

5.15 Consolidate the results of all inventory verification made involving the
same taxpayer with multiple inventory locations where simultaneous
stocktaking of stores, warehouses, or bodegas was undertaken.

5.16 Compute the applicable deficiency taxes arising from

over/understatement of inventories by using the following pro-forma
computation:

a. COMPUTATION OF OVER/UNDER DECLARED INVENTORIES

Ending Inventory per Return P XXX

Ending Inventory per Physical Inventory Count
(Refer to Inventory Count Sheet as Adjusted) XXX
Difference Over/(Under) P XXX

b. COMPUTATION OF GROSS MARK-UP ON COST OF SALES

Gross Profit per Audited F/S P XXX

Cost of Sales (COS) per Audited F/S P XXX

Percentage of Gross Mark-Up on Cost of Sales XX%

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c. COMPUTATION OF ESTIMATED GROSS PROFIT
(Applicable only for overstated inventory in computation (a) above)

Amount of Overstated Inventories P XXX

Multiply by: Rate of Gross Mark-Up vs. COS
[computation (b) above] XX%

Estimated Gross Mark-Up P XXX

d. COMPUTATION OF DEFICIENCY TAXES

d.1 Assumption I – Overstatement of Ending Inventory

(a) Computation of Deficiency Income Tax shall be

computed as follows:
Taxable Income per Return P XXX
Add: Estimated Gross Mark-Up [Computation [c] above] XXX
Taxable Income per Investigation P XXX
Tax Due Thereon (xx%) P XXX
Tax Paid per Return XXX
Basic Deficiency Income Tax P XXX

(b) Computation of Deficiency VAT shall be computed as

follows:
Amount of Overstated Inventory P XXX
Add: Estimated Gross Mark-Up [Computation [c] above] XXX
Amount not subjected to VAT P XXX

Basic Deficiency VAT (1/11 of the above amount) P XXX

d.2 Assumption II – Understatement of Ending Inventory

(a) Computation of Deficiency Income Tax shall be

computed as follows:
Taxable Income per Return P XXX
Add: Amount of Understated Inventory
[Computation (a) above] XXX
Taxable Income per Investigation P XXX
Tax Due Thereon (xx%) P XXX
Tax Paid per Return XXX

Basic Deficiency Income Tax P XXX

(b) No tax implication for Value-Added Tax purposes on the premise that
undeclared inventories do not constitute items/goods deemed sold.

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 While this Order aims to provide the most possible comprehensive procedures in
the conduct of inventory verification, it cannot accommodate all possible
scenarios the Revenue Officers may encounter in the conduct thereof.
Accordingly, the concerned Revenue Officers are not precluded from performing
other procedures and techniques which they may deem appropriate and relevant
under the circumstances.

VI. REPORTING REQUIREMENTS

1. Reports by Revenue Officers

The following documents shall form part of each and every report on
inventory verification to be submitted by concerned Revenue Officers:

1.1 A Standard Verification Report Form (Annex “F”) shall be used for
the reports on all the tax liabilities affected by the inventory
verification.

1.2 A narrative memorandum report shall be prepared setting forth the

result of the verification and should contain the following
information:

a. The basis of authority to verify the inventory (Mission Order

Number, dates of issuance and service and the period covered);

b. Profile of the taxpayer, particularly the type of business

organization, nature of business, product line(s), other sources of
income, information of its registration with other agencies such as
the SEC, BOI, PEZA, etc.;

c. The tax liability(ies) to which the taxpayer is subject, whether

income tax, value-added tax, percentage tax or other internal
revenue taxes;

d. A brief description as to the circumstances surrounding the service

of the Mission Order, inventory count undertaken, delays
encountered and reasons therefor, other verification procedures
adopted, relevant records checked, actual status of inventory
records, and dates and result of conferences;

e. Results of verification summarizing the discrepancies discovered

and basis of computation of recommended deficiency taxes, if any,
and

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 f. A recommendation as to issuance of termination letter after
collection of the deficiency tax, if any, and approval of the case or
issuance of assessment notice for deficiency taxes.

1.3 The Revenue Officers shall attach all working papers and all
documentary evidences that relate to their findings in the course of the
inventory verification.

1.4 The following documents shall likewise be attached to the docket:

a. Photocopy of Mission Order;

b. Copy of the inventory list as of December 31, 2002 (or end of

applicable fiscal periods) duly received by the concerned office;

c. Copy of the inventory list and supporting count sheets at the time
of the stocktaking or physical count duly signed by the taxpayer,
his representative or any responsible company personnel;

d. Revenue Officer’s Audit Reports (BIR Form 0500 Series);

e. Copy of Payment Form (BIR Form 0605), if deficiency tax was

paid;

f. Informal Conference Letter with the taxpayer and the summary of

the results of said conference(s);

g. Agreement form, if applicable;

h. Table of contents.

2. Report by Chief, LTAID/Chief, LTDO/Revenue District Officers

2.1 Monthly Report of Closed Cases on Inventory Verification (Annex “G”)

2.2 Monthly Report of Pending Cases on Inventory Verification (Annex “H”)

The above reports shall be prepared and submitted not latter than the 10th
day of the following month and to be distributed as follows:

Original - ACIR, Assessment Service

Duplicate - ACIR, LTS/Regional Director

Triplicate - Review and Evaluation Group, LTS/Chief,

Assessment Division

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 Quadruplicate - File copy

3. Report by the Head, Review and Evaluation Group (LTS)/Chiefs, Assessment

Divisions

The Monthly Report of Terminated/Assessed Cases on Inventory

Verification (Annex “I”) shall be distributed as follows:

Original - ACIR, Assessment Service

Duplicate - ACIR, LTS/Regional Director

Triplicate - File copy

This report shall be submitted on or before the 15th day of the following
month.

4. Report by the ACIR, LTS/Regional Director

The List of Mission Orders Issued for Inventory Verification (Annex (“J)
shall be prepared on or before the 5th day of the following month to be
distributed as follows:

Original - ACIR, Assessment Service

Duplicate - Review and Evaluation Group, LTS/Chief,

Assessment Division

Triplicate - File copy

5. Report by the ACIR, AS

The Consolidated Monthly Report on Assessments/Collections Arising from

Stocktaking/Inventory Verification (Annex “K”) shall be distributed as
follows:

Original - DCIR, Operations Group

Duplicate - File copy

This report shall be submitted on or before the 25th day of the following
month.

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VII. REPEALING CLAUSE

The provisions of Revenue Memorandum Order No. 18-95 and all other
issuances inconsistent herewith are hereby modified or repealed accordingly.

VIII. EFFECTIVITY

This Order shall take effect immediately upon approval.

(Original Signed)
GUILLERMO L. PARAYNO, JR.
Commissioner of Internal Revenue

I-1

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