Under invoicing when the mentioned value of goods in the invoice is less than the actual value of the goods or services purchased. For instance, you’ve purchased product A and paid $1,000 against it. However, when looking at the invoice, you notice that declared value of the goods in the invoice stands at $600. In this case, you’ve $400 ($1,000-$600) as under invoice amount.
Let’s further explore potential reasons for the under-invoicing.
- Tax evasion – Under invoicing may be an intentional act to save the taxes. As we understand, taxation and other duties are levied on the invoice value. So, a decrease in invoice value will lead to decreased tax costs, which is not only unethical but illegal.
- Profit shifting– Multinational companies may use under-invoicing to shift profit from a higher tax territory to a lower tax territory. For instance, the company might dispatch goods at a lower price/under-invoiced from a country with a higher tax rate to a country with a lower tax rate. There are two financial benefits of this arrangement. In the selling country (higher tax rate), reduced revenue is recorded, leading to reduced book profit and tax expense. On the other hand, in the buying country (lower tax rate), higher profit is recorded because their purchase price is lower. Hence, they pay less tax in comparison. So, overall profit for the consolidated profit and loss statement is increased due to revenue shifting in the lower tax regime, but this practice is unethical, unprofessional, and illegal. Further, it’s important to note that Government authorities might place fines and penalties if companies are found to execute such malpractices.
- Corrupt practices like bribes & kickbacks– Some specific company personnel might be collecting bribes/kickbacks for generating under-invoicing.
- Error in the invoice – There may be a mistyping in the invoice value, leading to an under-valued invoice total.
Also read, External audit comprehensive guide
How to prevent under-invoicing?
Here are the controls that can be implemented to prevent under-invoicing.
- Implement controls on revenue– Implement some effective invoice controls like segregation of duties, real-time monitoring, policies & procedures documentation, accounting system integrations, and a due diligence mechanism for the credit customers.
- Bring automation– Automation ensures processes are connected & integrated. So, errors are avoided when data flows from one process to another. Hence, there are lower chances for data modification/under-invoicing as there is no human intervention.
- Make sure to reconcile revenue-supporting documents– Revenue-supporting documents like approved quotations, purchase orders, delivery notes, and invoices must be reconciled to ensure data integrity. It helps ensure malpractices like invoicing are avoided.
- Encourage whistleblowing practices– Sometimes, under-invoicing may result from some gap in internal controls & processes. Hence, an overall culture to escalate integrity can effectively avoid revenue-related risks.
- Implement pre & post-audit culture– Pre-audit is when the credibility of transactions is assessed at their creation. So, errors/misstatements can be identified and resolved promptly. On the other hand, post-audit is a periodic exercise executed on samples of transactions. So, if there is any gap/weakness in the controls, it’s identified and resolved.
Under invoicing is when the business sends an invoice to the customer with an amount less than the actual value of the transaction. The act of under-invoicing may be due to error or an intentional act of corruption/fraud. For instance, under-invoicing is used in cases of tax evasion, profit shifting in multinational companies, corrupt practices, or simply due to some error/mistake.
Implementing strong controls on the invoicing system helps avoid misappropriation of revenue like under-invoicing and other malpractices.