Retail Industry Audit Technique Guide

Retail Industry

Audit Technique Guide

NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date. All references to code sections are to the Internal Revenue Code (IRC) unless otherwise specified. Publication Date: February 2009

Table of Contents

Chapter 1: Description of the Retail Industry ................................................................................................ 5 Purpose for the Audit Technique Guide .................................................................................................... 5 Description of the Retailer ......................................................................................................................... 5 What Retailers Do ..................................................................................................................................... 5 Demographics of the Retail Industry ......................................................................................................... 5 Retail Entities............................................................................................................................................. 6 Useful Retail Web Sites............................................................................................................................. 6 Unique General Industry Terminology....................................................................................................... 6

Chapter 2: General Issues in Retail ............................................................................................................. 8 Initial Interview ........................................................................................................................................... 8 Information Document Request................................................................................................................. 9 Books and Records ................................................................................................................................... 9 Income Issues ......................................................................................................................................... 10 Cash Records ...................................................................................................................................... 10 Indirect Methods .................................................................................................................................. 11 Sources of Receipts ............................................................................................................................. 16 Other Retail Income Sources............................................................................................................... 20 Cost of Goods Sold ................................................................................................................................. 21 Retail Inventory: IRM 4.43.1 ............................................................................................................... 21 Personal Consumption of Inventory..................................................................................................... 22 Retail Inventory Method (RIM): IRM 4.43.1.3.1 ................................................................................... 22 Last In, First Out (LIFO): IRM 4.43.1.3.1.3 .......................................................................................... 24 Stock Ledger (INVENTORY): IRM 4.43.1.3.2.5.4 ............................................................................... 24 Point of Sale Perpetual Inventory Control System .............................................................................. 24 Valuation Of An Acquired Retailers Inventory (PDF) (Coordinated Issue) .......................................... 24 Purchases ............................................................................................................................................ 24 Expenses ............................................................................................................................................. 25 Excise Tax Issues ................................................................................................................................ 27 Employment Tax Issues/Information Returns...................................................................................... 27

Chapter 3: Examination Techniques for Specific Industries ....................................................................... 29 Electronic Business, Online Retail .......................................................................................................... 29 Introduction .......................................................................................................................................... 29 Internet Investigative Tools .................................................................................................................. 29 Audit Techniques & Interview Questions ............................................................................................. 30 Income ................................................................................................................................................. 33 Cost of Goods Sold .............................................................................................................................. 33

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Expenses ............................................................................................................................................. 33 Glossary ............................................................................................................................................... 35 EXHIBIT 1: E-Business........................................................................................................................ 35 Video/DVD Rental Business.................................................................................................................... 42 Introduction .......................................................................................................................................... 42 Income ................................................................................................................................................. 42 Cost of Goods Sold .............................................................................................................................. 42 Expenses ............................................................................................................................................. 42 Glossary ............................................................................................................................................... 43 Statistics............................................................................................................................................... 44 Gasoline Service Stations ....................................................................................................................... 45 Introduction .......................................................................................................................................... 45 Initial Interview Questions .................................................................................................................... 45 Income ................................................................................................................................................. 46 Expenses ............................................................................................................................................. 50 Web Sites............................................................................................................................................. 57 Glossary ............................................................................................................................................... 57 Statistics............................................................................................................................................... 59 Independent Automobile Dealerships ..................................................................................................... 60 Introduction .......................................................................................................................................... 60 Initial Interview ..................................................................................................................................... 63 Books and Records.............................................................................................................................. 66 Income ................................................................................................................................................. 66 Cost of Goods Sold and Purchases/Inventory..................................................................................... 72 Purchases from Other Dealers ............................................................................................................ 73 Expense Issues.................................................................................................................................... 77 Related Finance Companies ............................................................................................................... 77 What is a Non-Prime or Sub-Prime Finance Contract?....................................................................... 80 Direct Sellers ........................................................................................................................................... 89 Introduction .......................................................................................................................................... 89 Income Issues...................................................................................................................................... 91 Partnership v. Sole Proprietorship ....................................................................................................... 96 Employee v. Independent Contractor .................................................................................................. 97 Profit v. Not-For-Profit Issue ................................................................................................................ 98 Nine Factors and Analyses .................................................................................................................. 99 Examination Practices ....................................................................................................................... 102 Websites For More Information: ........................................................................................................ 103 Code Sections, Revenue Rulings and Court Cases .......................................................................... 103 Auto Body/Repair .................................................................................................................................. 106

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Introduction ........................................................................................................................................ 106 Description of Auto Body Repair Process ......................................................................................... 106 Initial Interview ................................................................................................................................... 108 Tour of Business ................................................................................................................................ 109 Books and Records............................................................................................................................ 109 Income ............................................................................................................................................... 111 Categories of Charges ....................................................................................................................... 113 Other Income Sources ....................................................................................................................... 114 Indications of Underreporting............................................................................................................. 115 Other Income Issues.......................................................................................................................... 116 Cost of Sales...................................................................................................................................... 117 Expenses ........................................................................................................................................... 120 Glossary ............................................................................................................................................. 121 Chapter 4: Examination Techniques for the Food and Beverages Industries .......................................... 125 Retail Liquor Stores ............................................................................................................................... 125 Introduction ........................................................................................................................................ 125 Income ............................................................................................................................................... 125 Cost of Goods Sold ............................................................................................................................ 126 Statistics............................................................................................................................................. 126 Mobile Food Vendors ............................................................................................................................ 127 Introduction ........................................................................................................................................ 127 Income ............................................................................................................................................... 127 Cost of Goods Sold ............................................................................................................................ 127 Expenses ........................................................................................................................................... 128 Glossary ............................................................................................................................................. 128 Pizza Restaurants ................................................................................................................................. 129 Cost of Goods Sold............................................................................................................................ 129 Expenses ........................................................................................................................................... 129 Restaurants and Bars ............................................................................................................................ 130 Introduction ........................................................................................................................................ 130 Income ............................................................................................................................................... 130 Cost of Goods Sold ............................................................................................................................ 136 Expenses ........................................................................................................................................... 138 Web Resources for Restaurants........................................................................................................ 141 Glossary ............................................................................................................................................. 141 Statistics............................................................................................................................................. 145 Grocery Stores ...................................................................................................................................... 146 Initial Interview Questions .................................................................................................................. 146 Income ............................................................................................................................................... 146

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Cost of Goods/Inventory .................................................................................................................... 148 Chapter 5: Code, Regulations and Revenue Rulings, Procedures, Court Cases, and IRMs ................... 149

Cited Code Sections .............................................................................................................................. 149 Cited Regulations .................................................................................................................................. 152 Cited Revenue Rulings and Revenue Procedures................................................................................ 153 Cited Court Cases ................................................................................................................................. 155 IRMs ...................................................................................................................................................... 156

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