Scrap. It can be part of every manufacturing operation, usually pretty insignificant.

However, in some industries, there can be material dollars that are just a natural byproduct of the manufacturing process. If not being careful about it, scrap can be another byproduct. That byproduct is an IRS audit.

Scrap is something that I’m hearing is on the radar of the IRS these days as they come out to do their periodic audits. Why?

Here’s what can happen with scrap. It can be a way of skimming money out of the company. The scrap that’s generated during the manufacturing process is recorded as an expense. However, that’s one man’s scrap can be another persons gold. In many cases, they’ll be a market for the scrap. So, what unscrupulous companies might do is sell the scrap, but instead of reporting that income on the books the owner profits the scrap rebates personally.

So, be prepared for this should your number be called for an IRS audit. An audit doesn’t necessarily mean that there is anything wrong at your company; it may be it’s just your time to be reviewed. So, what should you expect?

1. When the IRS comes out to visit, part of this will be to do a plant tour. Expect that they’ll be some questions regarding scrap that might come up. For example, if you have areas where scrap is stored in your plant before it’s disposed of to a part that buys the scrap from you, you can expect that that will trigger some question, such as how long does it take to build up this level of scrap. How do you dispose of it? Do you have to pay to get this scrap taken out or is somebody paying you?

2. Take a look at your books. How is the scrap income reflected? Is it shown on the books? Is it pretty clear?

So, be prepared. This could be a part that you might not have anticipated that could come up on the radar with the IRS. Handle it properly, so you don’t let a small area become inadvertently a big area. The IRS may feel where there’s smoke, there’s fire and if they sense something wrong here that can open the door to bigger investigations in other parts of your company.

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value