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© by Greta P. Hicks, CPA

Source: IRS Audit Technique Guide for Mobile Food Vendors and Expresso Bars.

General

The espresso industry extends and continues to evolve into other type of situational settings. Espresso bars are proliferating into many other existing businesses including restaurants and cafes, fast food operations, department stores, supermarkets, "mom and pop" groceries, and convenience stores. Thus, an espresso bar may be a significant income producing segment of a business not exclusively devoted to marketing espresso products. The information in the Audit Technique Guide should be used in auditing an espresso bar segment of other businesses.

Underreporting of gross receipts is probably the most significant potential issue in auditing mobile food vendors. The mobile food vendor business tends to deal primarily in cash receipts from customers. As with any business that is cash intensive, the accuracy and adequacy of reporting income is highly contingent upon ownership and the owner's propensity for full and accurate reporting.

There are five indirect methods which have been developed by the Internal Revenue Service:

1. Bank deposit analysis

2. Cash transactions (cash-T)

3. Source and application of funds

4. Net worth

5. Percentage (or unit mark-up).


Estimating Techniques - Overview

The most accurate and reliable estimating method involves varied applications of the percentage (or unit markup) method. The ratio of espresso drinks to other products sold by the traditional espresso vending business has been approximately 75 percent espresso drinks to 25 percent for Italian sodas and other products including pastries, muffins, and cookies. During the past couple of years this appears to have been changing, and certainly varies from one vendor location to another. Additional products such as granita, bottled seltzers, bottled or canned soda drinks, soups, and in one observed instance, roses, have been added to the menus. Also, iced coffee drinks, such as iced latte, have become increasingly popular during hot summer months. Consequently, it is a good idea to observe the location in operation if possible and take note of menu items and prices, and to follow up as necessary through interview queries. Even where many other products are sold, espresso is still generally the mainstay and will account for the majority of total sales dollars. Espresso drink sales can be quite accurately estimated using bases of coffee and/or cups and lids. It is a good idea to use both, as one should corroborate the other.


Estimating Expresso Sales Based On Coffee Consumption

To estimate income from sales of espresso drinks via the coffee method, the following information is needed:

  1. Copies of invoices for all coffee purchased during the year. This is a major expenditure and we seldom encountered taxpayers who did not retain these. Most vendors purchase all their coffee from one supplier and make their purchases at consistent intervals throughout the year (usually at least weekly).
  2. An estimate of the average number of "shots" per drink sold. This is best obtained from the taxpayer, but if they don't know it should be relatively safe to use the ratio of 1.5 "shots" per drink which have corroborated by examinations. (Alternatively, one might divide the total "shots" produced by the total cups used to obtain an approximation.)
  3. An estimate or determination of the number of "shots" the taxpayer's grinder produces per pound of coffee. As mentioned earlier, grinders currently in use will produce between 64 and 75 "shots" per pound of coffee, depending on the grinder setting. For the project, examiners usually used 60 for income estimates. In one instance where the taxpayer objected to the 60 "shot" assumption and insisted that their grinder yielded 35, the examiner went to the cart location and observed an actual "pull" test conducted by the taxpayer. The result was 58 per pound.
  4. Documentation or an estimate of any bulk sales (sales by the pound of unground beans) and any coffee removed for personal use.
  5. An estimate of losses due to spillage, theft, or any other similar factor.
  6. Information concerning any marketing or promotion in which the customer was given drinks without charge. (For instance, many espresso vendors offer punch cards to the customer, and after the customer purchases so many drinks -- usually about 10 -- they are rewarded with a free drink.)
  7. An estimate of the average selling price per drink. The taxpayers are usually reluctant to make such an estimate, so your interview skills are vital to obtain this information. It is possible to set up a hypothetical situation with the taxpayer and get responses to a series of questions that will let you determine this average. For instance, you can create a hypothetical sample of the sale of 10 drinks and ask the taxpayer, based on their experience, how many will be lattes? Americanos? Mochas? Cappuccinos? etc. You can also ask, how many will be singles? Doubles, etc. Finally, determine from the taxpayer's menu or from oral testimony the selling price of each drink. Through this approach you can quite easily, based on the taxpayer's representations, determine ratios and extend the prices and then determine the average number of shots per drink and the average selling price per drink.
  8. Determine whether any applicable sales taxes are included in the selling price.
  9. Documentation or a reasonable estimate of the amount of coffee beans in beginning and ending inventories.


Estimating Sales Based On Cup And Lid Consumption

To corroborate the coffee use estimate, or in extreme cases as a substitute procedure, the "cup and lid count" method can be used also quite easily. Espresso vendors normally purchase cups and lids from a single supplier, but even if they purchase from several suppliers, adequate schedules can easily be prepared. The primary objective is to determine how many cups and lids were consumed. Similar to the preceding method, beginning inventories need to be accounted for and any shrinkage loss and free drinks need to be factored into the equation. The only other factor of significance that needs to be determined is whether and to what extent the vendor "double cups." Again, this information is quite simple to obtain in the interview, and can also be corroborated by a brief observation of the espresso vendor in operation.


NOTE: Vendors typically use 8 oz. and 12 oz. hot cups for espresso and may use either paper or Styrofoam. Italian sodas are most often sold in 16 oz. plastic cups.


Estimating Income From The Sale Of Italian Sodas

Italian sodas are cold drinks that are rising in popularity. The basic Italian soda consists of approximately two ounces of flavored syrup, several ounces of club soda, a generous amount of cubed ice, and are often complemented with one or two ounces of milk or cream. As noted above, these are commonly sold in 16 oz. plastic cups.

The flavored syrups most commonly used (currently) come in 26 oz. bottles, and in a wide array of flavors. Taxpayers have sometimes stated that they use 2 to 3 oz. of syrup per drink, but what is observed is that the use of 1 to 2 oz. is the norm. The cost of these syrups to the vendor usually ranges from $3 to $3.50 per bottle, depending on volume purchased and supplier.

Using techniques similar to those described above for estimating espresso drinks, it is relatively simple to estimate the income from the sale of Italian sodas. Simply determine how many drinks can be produced from each bottle of syrup used, multiply times the number of bottles of syrup used, and multiply the result times the selling price.


Estimating Income From The Sale Of Baked Goods

Sales of peripheral or complimentary items such as muffins, pastries, and cookies are increasing with maturation of the industry. Estimating income from these sales is actually not as difficult as at first might be imagined.

In the case of mobile food vendors, the amount of space available is usually limited, and the amount of space a vendor may occupy may be limited by the Health Department Regulations. Consequently, most mobile espresso vendors do not offer a wide variety of food items. In addition, the number of food vendors supplying the espresso vendor is usually limited to a very few.

Similar to estimating income from the sale of drinks, income from the sale of baked goods can be easily estimated by multiplying the quantity purchased times the selling price. This can be done for each item, or if the espresso vendor maintains a consistent profit margin on these products, the total dollars purchased can simply be grossed up to account for the profit margin using the percentage method. Examiners have noted that there is also very little waste or spoilage associated with selling these products. Espresso vendors typically purchase these several times a week, and in some cases daily, to maintain fresh products. In some instances the supplier may actually deliver to the espresso vendor daily, and will give credit for any unsold product.


Estimating Sales Of Coffee Drinks Based On Milk Products

Espresso sales in the study area have traditionally leaned heavily in favor of lattes and other "milk" drinks (between 80 and 90 percent of all espresso drinks sold). Because of this, there is a tremendous volume of milk products used by espresso vendors including whole milk, skim milk, half and half, and whipped cream. The milk is steamed or frothed, depending on the drink, and added to the espresso.

NOTE: Steaming or frothing generally expands the volume of the milk, especially frothing, to two to three the original volume.

Flavorings or whipped cream may be added. Although it is more difficult to establish average amounts used, it is possible to corroborate the coffee and lid and cup count methods based on the usage of milk. The procedure is basically as follows:

  1. Determine the ratio of "milk" based drinks for the vendor.
  2. Determine, if possible, the ratio of each size of drink and compute an average number of ounces per drink.
  3. Determine the "shot" ratio: Each shot of espresso produces about 11 ounces of liquid.
  4. Determine the additional liquid (milk product) needed on average to complete the average drink, keeping in mind that cups are seldom filled to the brim and that frothing tends to increase the volume of liquid.
  5. Compute (from invoices) the total volume of milk used in ounces, and divide by the average number of ounces of milk used per drink. The result is the number of milk based drinks sold.
  6. Divide the number of milk based drinks sold by its ratio to all espresso drinks sold. This will give you the total number of espresso drinks sold, which you can then multiply by the average selling price to estimate income

Survey After Assignment. A survey is used when the auditor considers a return without contacting the taxpayer, or representative, and concludes that an audit of the return would result in no material change in tax liability.

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GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing educational materials and programs on solutions to IRS problems and is a nationally known speaker and writer on solutions to IRS problems. To arrange for consultation contact: Greta's web site: http://www.gretahicks.com

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