Chapter 38: Perform an Internal Audit On Restaurant and Bar Operations
The purpose of this chapter is to demonstrate methods of auditing your restaurant or bar operation. These methods are helpful in locating and understanding cost control problems. These investigative methods are also useful when considering purchasing a restaurant operation. Many of these methods are utilized by IRS examiners as well as national restaurant chains. For this chapter, audit procedures will utilize liquor costs and liquor sales. These procedures also apply to food and wine.
PRE-AUDIT PLAN
An analysis of the tax return should be conducted to determine potential issues. One form of analytical review, comparing balance sheets and income statements, will give meaning to the changes that took place between the years; the individual figures are relatively meaningless. Large percentage changes not standard for the industry can be highlighted as potential issues for the initial interview focus. An important ratio computed on the comparative income statement is the gross profit ratio. It is computed from the following:
gross sales – cost of goods sold = gross profit
GROSS SALES RATIO
This ratio tells approximately how much of an item’s sale price represents gross profit and how much is a recovery of the cost of the item. During the initial interview, the manager/owner should be asked the markup percentage on the goods sold. The percentage obtained from the interview can be compared to the computed ratio to see if it is similar. If not, it is an indication that cost of goods may be overstated or revenues understated. An analysis of these accounts should be performed to determine if either is the case.
THIRD-PARTY SOURCES OF INFORMATION
The following represent possible third-party sources of information that can aid you in examining your bar or restaurant. The information may not be organized in the same way in your state; also, additional information may be available in your state. You should research your state to obtain the needed information.
• Alcohol Beverage Control. Demands that holders of on-premises licenses maintain available records of all purchases for three years.
• State Liquor Dispensary. Maintains records of all purchases by liquor license number. Does not maintain the details of the purchases. Maintains records of the liquor costs for most periods of time.
• Local beer/wine distributor. Maintains records of purchases made by customers. Maintains the records of the costs of the products. Permits required by the state.
• Building permits. Give cost of building. Also may contain blueprints of the building.
• Health Department Permit.
• Bank statement.
• Bank reconciliation.
• Paid-out recaps (by account classification).
• Unpaid bills recap (vendor and account classification).
• Equipment purchases (include copy of invoice).
• Payroll summary.
• Accrued payroll.
• Monthly and/or quarterly tax returns.
• Copies of daily and weekly profit and loss statements.
QUESTIONS PREPARED FOR THE INTERVIEW OF THE OWNER
1. Who runs the business? Is it family-operated or management-operated?
2. What are the duties of those who run the business?
3. What amount of time does each individual spend at the business?
4. What types of reports (tip reports, daily sales reports) are prepared for the business and who prepares them?
5. How much of the bookkeeping is done or kept at the business site?
6. Does the owner have an accountant or bookkeeper who maintains the bookkeeping system?
7. Who else has managerial control over the employees at the restaurant?
8. Does the management have any prior experience in the industry?
9. What are the days and hours of normal business operations?
10. What type of restaurant is it?
11. What type of clientele frequents the restaurant?
12. What is the customer capacity of the restaurant?
13. What are the average number of dinners sold on the weekdays and weekends?
14. What type of payment is accepted (cash only, credit cards, checks)?
15. What is the average cost of a meal?
16. Who determines the price of the meal?
17. What type of entertainment, if any, is offered?
18. Is there a cover charge for the bar or any entertainment at some time during the evening?
19. How are the entertainers paid?
20. Are banquet facilities available?
21. Is there a set fee for banquets or is the charge determined on an individual basis?
22. Is there a “Happy Hour?”
23. Are food specials offered daily?
24. What is the average number of employees on the payroll?
25. How many people are working on day, afternoon, or night shifts for the various areas of the restaurant?
26. What type of shifts do the employees work (day, afternoon, evening)?
27. How are employees paid: weekly, biweekly, or monthly?
28. Are any individuals working at the restaurant considered independent contractors?
29. How is time kept for the employees: sign-in or time clock?
30. What type of side duties, if any, do the employees have on a daily, weekly, or monthly basis?
31. Who calculates tips for each server?
Interview Questions
Management And/or Owner Interview
1. On what days is the restaurant open?
2. What are the restaurant’s hours of operation?
3. How many shifts are there?
4. What is the average number of employees on each shift: Captains? Wait persons? Bus persons? Others?
5. Does an employee work the same shift on a regular basis?
6. If not, how are shifts rotated? How are different shifts recorded?
7. Who sets up the room?
8. What is the average setup time?
9. How is setup time rotated?
10. If stations are not rotated, how are they assigned?
11. What is the seating capacity of the restaurant?
12. Are tips pooled and split among wait persons?
13. How are tips split?
14. If tips are not split, who gets tipped out and what percent of the tips do they get?
15. Where do customers pay for their meals? That is, do they pay the wait person or a cashier on the way out?
16. How do the employees receive their charge tips?
17. Do you have the following types of sales: Charge sales? Banquets? Complimentary sales? Ticket/Tour sales?
A. Approximately what percentage of sales does each of these types bring in?
B. How do the employees receive any non-cash tips for these types of sales?
18. Are wait persons required to pay for customers who leave without paying?
19. Does the average cash customer tip better or worse than the average charge customer? If so, by how much?
19. Do customers tip differently according to the time they eat?
20. Are there any unusual factors that affect tipping in your establishment?
21. Other Comments:
Employee Interview
1. Who is your manager?
2. How many shifts are there that you might be scheduled for in a given day?
3. How many hours are there in each shift?
4. Do all wait persons work setup and breakdown?
5. If not, who does and how long does it take?
6. Do you have a steady schedule?
7. Are shifts rotated?
8. How are they rotated?
9. How are stations assigned?
10. Are stations rotated?
11. How are they rotated?
12. What is the average number of tables per station?
13. What is the average number of chairs per station?
14. How many tables, on the average, do you serve per shift?
15. How many checks, on the average, do you write per shift?
16. Who assigns workstations?
17. Who assigns work shifts?
18. Does the average cash customer tip better or worse than the average charge customer? By how much?
19. Do you have to pay for walkouts? If yes, how often does this happen?
20. What is your position?
21. What are your duties?
22. How long have you worked at this establishment?
23. Have you worked in any other position at this establishment?
24. As a food server, do you consider yourself above average, average, or below average?
25. Is there a reason why a determination of average sales and tips would be unfair to you?
26. Other Comments:
INTERNAL CONTROLS: QUESTIONS FOR THE OWNER AND/OR MANAGER
Inventory
1. Who are the primary suppliers of the business? What do they supply?
2. When are the purchases recorded (daily, weekly)?
3. Who is responsible for making the purchases?
4. Are the purchases recorded from checks or invoices?
5. What types of records are available for purchases? For example, is there a purchase journal?
6. Are there any records available for the number and size of bottles of alcohol purchased?
7. Are purchase discounts available? Were they taken?
8. Do the suppliers offer kickbacks or rebates? How are they recorded?
9. How many ounces of liquor are in each mixed drink? What are the prices of the mixed drinks?
10. Is the inventory of alcohol and food stored in a locked storeroom?
11. Who has access to the storeroom?
12. Who restocks the bar from the storeroom inventory and at what intervals?
13. What type of record is maintained of stock being removed from the storeroom?
14. Does the bartender have to turn in an empty bottle before receiving a new bottle?
15. Who checks in incoming merchandise to the storeroom?
16. Are the contents of incoming cases verified?
17. Are automatic liquor-dispensing devices used?
18. What is the price per beer for imported beer? Domestic?
19. If draft beer is available, how many ounces are in a glass? A pitcher?
20. Is there a price list of drinks available?
A. Do you have wine for sale? By the glass and/or bottle?
B. How many ounces are in a glass? Carafe?
C. What are their prices?
21. What is the price of the wine coolers sold?
22. How many glasses of wine are served from each bottle?
23. What is the normal markup on mixed drinks? Beer? Wine? Wine coolers?
24. Do you compute spillage?
25. At what intervals are physical inventories of merchandise taken and who is responsible for it?
26. Is beginning bar inventory plus storeroom withdrawals less ending inventory periodically extended to retail prices and compared to receipts?
27. Who checks incoming inventory for the kitchen?
28. Are incoming shipments weighed?
29. Once the incoming inventory has been accounted for, what happens to the receiving document?
30. Do the employees eat on the premises? Are they given the meals at a discount?
31. Are written records maintained for complimentary and employee-consumed meals and drinks?
INTERNAL CONTROLS — CASH
1. How are sales by the wait staff controlled?
2. Are prenumbered meal tickets used for each customer and/or table? If so, how are they issued to each server?
3. How is each server responsible for his or her numbered meal tickets?
4. What happens to voided meal tickets?
5. Does someone in management verify voided tickets?
6. Are cash registers used for the restaurant and/or bar?
A. Where are they maintained?
B. Are they preset for the individual menu or drink items?
7. Who has access to the cash registers?
8. Are cash-register drawers closed after each sale?
9. Do the cash registers print sales tickets?
10. How are over-rings handled?
11. Are sales tickets given to the customers?
12. Is access to the register tapes restricted? To whom?
13. Are the registers closed out at the end of each shift? By whom?
14. Are beginning and ending cash-register transaction numbers compared?
15. If two or more bartenders and/or hosts, etc. work simultaneously, do they use the same or different cash registers?
16. Are cash-register readings taken during each cashier’s shift?
17. Is the cash reconciled to the register tapes and deposited in the bank intact? If so, at what intervals and by whom?
18. How are expenses for the business paid?
19. Are any expenses paid in cash? If so, are these amounts accounted for?
20. What types of controls are placed on the cash?
21. Who has access to the cash receipts?
Other Information
1. Who determines the prices of the meals offered?
2. How are portions controlled?
3. Do you have valet parking?
4. What happens to the money received for valet parking?
5. What type of advertising is used?
6. Are there any promotions used?
7. What happens to the used grease?
8. Are there any coin-operated machines in the restaurant/bar?
9. What is the age and condition of the equipment?
10. What is the employee turnover?
BALANCE SHEET EXAMINATION
An examination of the balance sheet can be advantageous for detecting items not found through the examination of the income statement. This section provides a correlation between the balance sheet and the income statement. By properly planning an examination, one can eliminate a duplication of effort and conduct a thorough examination. The following information can be used to conduct the examination:
• A detailed examination of accounts receivable can eliminate the sales cutoff procedures of the income statement.
• An analysis of the bad-debt reserves on the balance sheet will determine if the provision to the bad-debt reserve is reasonable.
• An analysis of the debits of the prepaid assets will verify what items are being amortized or expensed.
• A detailed examination of the fixed assets and the accumulated depreciation would eliminate the need to verify depreciation expense.
• Examining accounts payable can eliminate the need to audit the accrued amounts that were expensed on the income statement. Similarly, examining loans payable will eliminate the need to verify interest expense.
The first step in examining the balance sheet is to prepare a comparative balance-sheet analysis. A minimum of three years will be involved: the assigned year and the prior and subsequent years. These three years will provide four years of “end-of-year” balances.
The primary emphasis in this examination of the balance sheet is placed on the last year.
It eliminates the duplication of efforts for each year examined because of “rollovers”. Rollovers are items that would affect the subsequent years if they were adjusted. It is at the agent’s discretion whether prior years’ balances are to be adjusted just for the interest due to the government.
Cash in the bank should be reconciled between book balances and the bank statements. Generally the taxpayer’s accountant will have bank reconciliations available to inspect or examine. The bank reconciliation(s) should then be reconciled to the tax return.
UNREPORTED INCOME
Normal audit procedures, tracing gross receipts to bank deposits, doing a bank deposit analysis on the business bank accounts, should be performed. Restaurants and bars are cash driven establishments. Cash can be hard to tie down in a bank deposit analysis if the cash is not being deposited into the bank accounts. Therefore, it is important to tie down the cash that is collected as gross receipts from every source and the cash that is paid out as expenditures. In the income statement section an indirect method is presented on how to audit the gross receipts from a bar or restaurant; however, consider the following techniques in auditing the cash on the balance sheet.
INTERNAL AUDIT TECHNIQUES
• Obtain the year-end reconciliation and compare it to the books. Outstanding checks should be considered income.
• Likewise, the most recent outstanding checks should be examined to determine if the taxpayer engages in drawing checks but not issuing them promptly. This practice is usually applicable to cash-basis taxpayers. If you believe this practice exists, observe the dates checks were paid, as stamped by the bank on the cancelled checks. Another way is to look for a credit balance in the cash account indicating checks drawn but not issued until later.
• Using cancelled checks, test one month’s returned checks in the following manner: Compare the name of the payee with that of the endorser. If they do not agree, or if the name of any officer, partner, or shareholder appears as secondary endorser, determine why. The cash disbursement book should be open to the appropriate month while this is being done. If the payees of any checks are the officers, or if the checks are drawn to “bearer” or “cash,” look at the cashbook to see if the payee described is the same one named on the check itself.
• Review the cash disbursements journal for a selected period. Note any missing check numbers and large or unusual items. Determine the propriety of these items by comparing with vouchers and other records.
• Determine if voided checks have been properly handled.
• Review the cash receipts journal for items identified as ordinary business sales and be alert for items such as sale of an asset or prepaid income.
• Review entries in the general ledger under “Cash Accounts” for unusual items that do not originate from the cash receipts or disbursements journal. These entries may indicate unauthorized withdrawals or expenditures, sales of capital assets, or omitted income.
• Determine whether the taxpayer has included interest income from time deposit accounts.
• Verify that any method of inventory valuation conforms:
A. Compare inventory balances in the return with the balances for the prior and subsequent years’ returns and verify.
B. Check for unauthorized changes from cost to cost or market.
C. Check for gross profit percentage variations.
D. Determine meaning and significance of any notes or qualifying statements on financial reports prepared by independent accounting firms.
E. Determine that all direct and indirect overhead and burden expenses are in the overhead pool that is used in the computation of overhead rates where applicable.
F. Analyze unusual entries to cost-of-sales account for labor, material, and burden charges not directly related to sales or transfers of finished goods, if applicable.
G. Confirm that year-end purchases were included in closing inventory.
H. Determine whether there have been write-downs for “excess” inventory at below cost. Verify the method of inventory valuation for “excess” inventory.
DISCRETIONARY AUDIT PROCEDURES
1. Compare prior year’s closing inventory with current year’s opening inventory.
2. Determine whether a consistent and acceptable pricing method has been used.
3. Review manner in which overhead has been applied to inventories.
4. Review all inventory adjustments to ensure that no premature write-downs or reserve of anticipated losses have been included therein.
5. Where obsolescence adjustments have been made, review usage for prior, current, and subsequent years.
6. Where a standard cost system is used, review the factors composing the standard frequency of updating and disposition of variances.
7. Test end-of-year purchases and accruals to ensure inclusion of these items in inventory.
LOANS TO SHAREHOLDERS — AUDIT TECHNIQUES
Most bar and restaurant corporate returns will be organized as closely held corporations. Many of these will have loans to the shareholders. The following information will provide the general audit techniques to use when addressing this issue.
Obtain copies of any notes or evidence of indebtedness. Test them to see if the terms of the note are being followed. Is interest being accrued as income? Does the loan call for monthly payments or is it payable on demand? Does the note have a fixed maturity date? Does it have an interest rate? Is the interest rate near market? The absence of one or all of the above may indicate the loan was made at less than an arm’s length transaction or below the prevailing market rate and may be construed as a constructive dividend (or, in an alternative position, interest income).
DISCRETIONARY AUDIT PROCEDURES
1. Analyze the composition of the account balance.
2. Trace the source of repayments.
3. Determine whether or not a bona fide debtor-creditor relationship exists.
4. Ascertain whether the current year’s increase represents dividends.
5. Confirm that interest income has been properly recorded.
FIXED ASSETS
The initial investment for starting a restaurant or bar is quite high. Capital is required for the purchase of the property, leasehold improvements, equipment and furnishings, possible franchise fees, licenses, permits, taxes, liquor licenses, utilities, insurance, food inventory, advertising, and payroll. The basic fixed assets that will be found in any bar or restaurant are as follows:
A. Kitchen equipment. Stove, grill, fryer, walk-in freezers, walk-in refrigerators, ovens, dishwashers, and storage equipment.
B. Office equipment. Desk, computer, and telephone.
C. Property. Fencing, building, and outside seating.
D. Dining room. Tables, chairs, music (stereo/speakers), jukebox, cash register, floor coverings, salad bar, coffee makers, soda fountains, silverware, glassware, and dishes.
E. Bar. Refrigerators, cash register, sinks, bar, glassware, ice machine, ice bin, draft beer dispensers, alcohol dispensers, telephone, and coin-operated machines.
AUDIT PROCEDURES
1. Review the acquisitions to confirm that they have been properly recorded.
2. Where the acquisition consideration is other than cash, fully review the manner of arriving at basis.
3. Does the basis include all expenditures required to place the asset in readiness for operating use?
4. Allocations should be reviewed where a lump-sum purchase price is involved.
5. If there is an allocation in the contract between buyer and seller, verify that the allocation is consistent with the agreement. Also, verify that the allocation reflects economic reality.
PROFIT AND LOSS STATEMENT EXAMINATION
Examining the profit and loss statement may be the quickest and easiest way to perform an audit on a bar or restaurant. This approach is limited, however, when examining the gross receipts of the establishment. Since these establishments deal largely in cash, you will need to determine if the internal controls in place are adequate to ensure that the cash is being deposited into the bank accounts. Because of this uncertainty, an indirect method — besides a bank deposit analysis — may be warranted.
AUDIT TECHNIQUE
The first step in examining the profit or loss statement is to prepare a comparative analysis. Generally, a minimum of two years will be involved: the assigned year and the subsequent year. Based on the analysis, unusual or significant fluctuations in account balances can be selected for a more detailed examination.
The primary emphasis of an examination of the profit or loss statement is placed on “permanent” types of issues. Permanent types of issues are contrary to the “rollover” types of issues and do not affect the subsequent year: travel and entertainment, political contributions, investment tax credit, and investment tax credit recapture.
NOTE: Not all classifications of income or expenses are included in this package, which does not imply that the other items are correct or should not be audited.
SALES
The sales generated by a bar or restaurant are generated from the following sources: food, receipts, beverages (alcoholic and nonalcoholic), and coin-operated machines. The sales generated from these sources are hard to trace, since income is being generated by every customer. Also, the level of sophistication of the books may be poor. To gauge the daily, weekly, or monthly performance of sales, you will have to rely heavily on the information obtained in the initial interview, such as the number of meals sold in a typical day, average price of a meal, and markup percentages on food and alcohol.
If you can obtain accurate information in these areas, you will be able to accurately estimate the sales for a specific period. This estimate will enable you to determine if unreported sales are possible. If it is discovered that underreporting exists, further detailed analysis of the information gathered will ensure that the underreporting can be adjusted in the examiner’s report.
Since the bar/restaurant business is largely cash based, the use of the indirect methods discussed in this section may only uncover that an understatement of income exists; it may be difficult or impossible to detect how the understatement came about.
The taxpayer may only be reporting income from one cash register when two are used. The only possible way to uncover this deceit is to ask a lot of questions and keep your eyes open during the tour of the business. Another helpful technique would be to visit the operation during its normal business hours and observe how the transactions are handled or send in a secret shopping service.
Income From the Sale of Food
The formula below can provide a reasonable estimation of annual sales for you to compare to figures on the tax return. The numbers used should be derived from the initial interview. Any large discrepancy between the income derived from these numbers and those reported on the tax return may indicate unreported income or inflated expenses. You should then look closely at the pertinent accounts (such as food/beverage purchases, monthly sales) in the books and records.
possible daily volume x average check per seat = daily sales
The possible daily volume is the number of seats in the establishment multiplied by how many times in a day they are occupied. The possible daily volume can be broken down into time periods — breakfast, lunch, or dinner — to get a more accurate tally.
The average check per seat can be obtained from the initial interview or past records. The daily sales can be extended to weekly and yearly sales based on the days open in a week and the weeks open in a year.
daily sales x days open in a week = weekly sales
weekly sales x weeks open in a year = yearly sales
These estimates can be accurate if consideration is made for vacant seats and people who walk out before paying their bills. During the initial interview ask enough pertinent questions to determine if these or any other situations should be considered.
Normal audit procedures should be performed. Consider the interview responses received concerning internal controls. Does the same person who counts the daily receipts also make the bank deposit? Are the meal orders taken on numbered tickets or is it easy to not ring up a sale on the cash register for some orders? Look closely at the supervision habits in the restaurant to evaluate how sales might be understated or how easily theft may occur and by whom.
The advertising account should be examined to test the accuracy of reported income. Are specials advertised? How often? Specials may refer to certain menu items or discounted prices or both. Are the times during which specials are offered (such as Happy Hour, breakfast hours) reflected in the daily receipts ledger?
Cash Transaction Analysis, Net Worth, And Other Indirect Methods
A cash transaction analysis, net worth, or other indirect method may be used to determine an understatement. One way to further support your suspicions of an understatement is this indirect method: Inspect the supply invoices to find the name of the printer of the guest checks. This printer can provide the number of guest checks purchased by the restaurant in a year. A projected income can then be determined from the average guest-check dollar amount multiplied by the number of checks. If these indirect methods are used in combination, they strengthen the case.
Even in states where the distribution of liquor is carefully regulated, the bar owner may remove cash from his drawer; purchase liquor off the shelf at a store; sell the drinks in his establishment; and return the amount of cash to the drawer, while pocketing the profits. In such a case there usually will be no indication in the books that anything is wrong, as neither the invoice nor the income touches the books. An indirect method may uncover this subterfuge.
Income From The Bar
The auditing techniques used depend on the quality and quantity of the books and records maintained by the taxpayer. If the examination consists of a larger bar — where there are inventory records maintained that detail the daily and/or monthly purchases and quantities sold — then the liquor cost percentage can be computed and applied to total purchases to determine the gross receipts and gross profit of the taxpayer. If the examination is of a smaller, “Mom and Pop” bar chances are it is going to be time- consuming and difficult to determine the purchases for one day or one month. In this situation it might be better to rely partly on third-party information to verify purchases and compute the markup on cost. The markup can then be applied to total purchases to determine the gross receipts and gross profit.
Using The Liquor Cost Percentage To Compute Gross Receipts
To compute gross receipts using the liquor cost percentage, the following steps should be followed:
1. Determine the cost of some of the more popular brands of liquor.
2. Determine the sales value of the bottles if all liquor out of these bottles was sold.
3. Divide the sales value into the cost to get the potential pouring cost.
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Example 1 1. Determine the cost of liquor. Verify from third-party sources that the cost per quart (bottle) is, in fact, $4.48. 2. Determine the sales value of the bottle. A quart has 32 ounces in it. If there are one and one fourth ounces per drink, there are 25.60 drinks per bottle. (32 ÷ 1.25 = 25.60). If drinks go for $1.10, then the sales value per bottle — less sales tax of $1.97 — would be $26.19. (25.60 X $1.10 = $28.16 – $1.97 = $26.19) 3. Compute the liquor cost percentage. Divide the sales value into the cost, giving you the potential pouring cost. The sales value per bottle is $26.19 and the cost is $4.48, so the liquor cost percentage would be 17.1 percent. $4.48 ÷ $26.19 = 17.1% Conclusion: 17.1 percent of $26.19 is the cost. The rest is the markup. If this percentage is applied to total purchases of $5,000, the gross receipts should be $29,239.77. ($5,000 ÷ 17.1% = $29,239.77) Gross receipts (100%) 29,239.77 Less: purchases (17.1%) –$5,000.00 Equals: gross profit (82.9%) $24,239.77 |
The computations done with the formula discussed above can be used to calculate the total sales value of all bottles sold in a week, a month, or a year.
Using The Markup On Cost To Compute Gross Receipts
If it is difficult to determine daily and monthly purchases by an establishment, the markup on cost may be used to compute gross receipts and gross profit. This method works closely with the liquor cost percentage method; however, different percentages will be determined.
As with the cost percentage method, the cost and sales value of the various items need to be computed. Then the markup on cost can be computed. Markup on cost is the amount of the sales price over the cost of an item.
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Example 2 (simplified) price ($10) – cost ($5) = gross profit ($5) sales price ($10) ÷ cost ($5) = percentage markup (200%) The following steps should be followed to compute gross receipts based on markup on cost: 1. Determine the markup of the various alcoholic items sold. The markup should be determined in the initial interview. If the manager/owner does not know the markup of the bar items, you must compute it based on the sales price of drinks and the cost of the drinks. 2. Determine the purchases made. You can get this information off the invoices provided, if available and accurate. If not, you should request in the initial interview the names of all the vendors used. Send letters to the vendors requesting records of all purchases made. 3. Apply the markup to the purchases of the various types of alcohol. Using the figures from Example 2: purchases and total costs ($5) x markup (200%) = projected sales ($10.00) |
The steps discussed above do not take into account amounts for spillage or Happy Hour prices. This information must be determined in the initial interview so that these amounts can be adjusted in determining the correct gross receipts.
OTHER INCOME
Income From Coin-operated Activities
Another important area of income to audit is the receipts generated by the coin-operated machines located in a bar. Coin-operated machines include jukeboxes, cigarette machines, pool tables, and dartboards. These machines can be owned or leased from another party. If the machines are leased, the general rule is that the income generated from the machines is split based on some percentage determined by the owner of the machine. Income generated from coin-operated activities is very difficult to determine accurately. Therefore, it is important to ask a lot of pertinent questions in the initial interview regarding the operation of and income generated from these machines.
Other Activities
Other areas of income in a bar or restaurant are the sale of lottery tickets, check-cashing, cover charges, and gaming pools. Scrutinize these areas in the initial interview. Ask pertinent questions to determine if the business engages in these areas and how the cash is handled and reported on the tax return.
Cost Of Goods Sold
The cost of goods sold can be one of the largest expenses on the return. Be aware that the purchase figure reported might be a “plug” figure in order to balance the cost-of-goods-sold computation.
PURCHASES
1. Review the cutoff date. Confirm that year-end purchases were recorded in the proper accounting period.
2. Determine whether the owners consume or withdraw merchandise for personal use, such as food, liquor, appliances. If so, proper reductions should be made to purchases or cost of sales.
3. Scan “Purchases” column in the cash disbursements journal and voucher register for items unusual in amount and to payee or vendors not generally associated with the products or services utilized.
4. Review entries in the general ledger control account. Note and verify entries that originate from other than usual sources (general journal entries, debit, and credit memos).
5. Test check the recorded purchases for a representative period with vendor’s invoices and cancelled checks. Be alert to such items as personal expenditures and capital expenditures.
6. If purchases are made from related or controlled foreign entities, review a representative number of such transactions to determine if the following are present:
A. Prices in excess of fair market value.
B. Excessive rebates and allowances.
C. Goods or services not received.
7. Ascertain if merchandise, prizes, trips, etc. were received from suppliers as a result of volume purchases.