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Publication
Date - August 2005
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.
Table
of Contents / Chapter
2
Tax
Code, Regulations and Official Guidance Search
Chapter
1: Description of the Retail Industry
Purpose for the Audit Technique Guide
The purpose of this Audit Technique Guide is to provide
guidance on conducting income tax examinations in the retail
industry. It incorporates procedures and techniques that
have been shown to be practical or unique to the retail
industry, that will be combined with the examiner’s good
judgment, skill and experience to complete the examination
within the shortest possible time with the least burden
possible to the taxpayer. Use of these techniques does not
imply that the object of the examination is to find a
deficiency, but rather to determine whether the reported
income and expenses have been accurately reported.
Because
the facts and circumstances of each taxpayer are unique, the
procedures applied will be slightly different in every
examination, and the strategy will remain dynamic. The
examiner will combine the techniques that apply to each
specific case and apply his or her basic knowledge to the
practical situation at hand.
Description
of the Retailer
Retailers purchase items from a supplier or wholesaler for
re-sale at a profit. The retailer earns his living by making
a profit on the re-sale. To do this the retailer may offer
only one type of product, where there is little competition,
and use a substantial markup (such as an auto dealership),
or the retailer may offer many different products or models,
so customers will be certain to find an item to buy in this
store and not in a competitor’s store (such as a
convenience store). Some retailers earn a small profit on
many items and rely on the volume of sales (such as grocery
stores), or turnover, to account for their profits. For
these reasons, the retailer will constantly assess whether
items for sale are turning over properly, and if necessary,
will retire an item or product and introduce new items or
products for sale.
What
Retailers Do
Retailers purchase a product, mark up its cost, and
advertise it for sale. The mark-up process is the key to the
retailer’s business, because, if the product is marked up
too high, consumers will not buy it; if it is too low, the
retailer will have lost profits and the supply may be
quickly exhausted.
Another
key to the retail business is knowing what the customer
needs or wants and when, how much the customer is willing to
pay for the product, what the competition is charging, and
where to find the product at the best possible cost to make
a profit.
These
items and products held in the retailer’s possession are
called inventory. Inventory is money out of the retailer’s
pocket, so the retailer tries to keep available only the
amount that is needed. The retailer only makes money when
inventory is sold, and business profitability is measured by
inventory turnover rates.
All
decisions made in this process, finding the product to sell,
marking up its cost and placing it for sale, are made with
the expectation of earning a greater profit.
Demographics
of the Retail Industry
Retailing is one of the largest industries in the United
States and accounts for approximately 10 percent of our
gross national product. Retail business covers many
different areas, including auto dealerships, bars,
convenience stores, restaurants, gift shops, clothing
stores, merchandise stores, etc.
There
has been enormous growth and innovation in American
retailing in this century. Neighborhood markets and
drugstores of the early 1900’s have succumbed to
population growth and demographic shifts to become
department stores and grocery stores in the 1950’s. As
cities became crowded, families continued to move and the
interstate road system improved, suburban shopping centers
and malls were created. Chains, franchises and catalogs have
built them into national brands today. Retail warehouse
concepts continue to increase. Technology has enabled
product scanning, sophisticated marketing techniques and
Internet shopping.
During
the past 2 decades the retail industry has been a leader in
the number of mergers and acquisitions. During the
1980’s the Wall Street Journal stated that the retail
industry was “percolating with mergers and
acquisitions.” In recent years the retail
grocery industry has been involved in numerous acquisitions.
Technology
has played a significant role in acquiring and maintaining
inventory. It has allowed a “partnership” between
vendors and retailers in quick response replenishment of
inventories. Point-of-sale terminals, bar coding,
customer credit cards, etc., have led to better, more
accurate recordkeeping by retailers.
Retail
Entities
Small retailers are sometimes called ‘mom and pop’
stores because they are family owned and operated. An
example of this might be a generic convenience store or a
boutique in a strip mall. This type of business may be
a sole proprietorship. Even if both spouses work in
the store, only one may be the proprietor. Only the
proprietor spouse may pay self-employment tax.
It
is not unusual for ‘mom and pop’ stores to enter into a
partnership, or for family members to form a partnership.
This might be done to give each member a share in profits or
it might be formed because the business is growing.
Large
retailers may include many store locations and hundreds of
employees. Both small and large retailers might
include activities reported as sole proprietors on Form
1040, Schedule C, as partnerships on Form 1065, or as
corporations on Form 1120 or Form 1120S.
Useful
Retail Web Sites
Some useful web sites we recommend looking at include:
Unique
General Industry Terminology
There is some terminology and practices unique to the
industry. It is recommended that examiners familiarize
themselves with the terms unique to this industry prior to
the initial interview in order to facilitate the
examination. Each Retail sub-industry will also have it’s
own unique terminology. See the particular industry section.
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Industry
Term
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Definition
or Explanation
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Bar
Code
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A
series of vertical or horizontal parallel lines
forming a code that is optically read and interpreted
by a bar code scanner. Used on envelopes and
forms for rapid entry of data and for sorting.
Bar coding may be an indication that the inventory is
computerized.
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Chargebacks
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The
retailer’s invoice for claims against a vendor
resulting from items such as damaged merchandise,
cooperative advertising costs, adjustments, and the
recovery of transportation charges for improperly
routed merchandise. Chargebacks are usually
shown on the vendor’s invoices.
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Cooperative
Advertising
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Advertising
paid for jointly by the advertiser and its wholesalers
or retailers. For example, the landlord of a strip
mall may collect a percentage of advertising from each
tenant. This is used for advertising that will
benefit all of the tenants.
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Cost
Complement
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The
average relationship existing between the cost of
merchandise and the retail value of the items handled
during an accounting period. The dollar value of the
inventory at cost is divided by the dollar value of
the inventory at retail.
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Layaway
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A
method of deferring payments whereby goods are
retained by the store until the customer has completed
payments for them.
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Markdown
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A
reduction of an originally established selling or
previous retail price.
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Markup
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The
difference between cost price of goods and their
retail price. The initial margin between the selling
price and cost. It also is referred to as
mark-on or gross margin.
Additional
markup: An increase above the original selling
price.
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Markup
Cancellations
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A
reduction in the price of an item after it has been
subject to an additional markup. Markup
cancellation never exceeds the amount of additional
markup applied to an item.
An
increase in the selling price, following a markdown,
which does not raise the new selling price above the
original selling price.
Markdowns
less markdown cancellations are referred to as net
markdowns.
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Markdown
Cancellations
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The
increase in the retail price of an item that has been
reduced.
A
reduction in the selling price after there has been an
additional markup. The reduction does not reduce
the selling price below the original selling price.
Additional
markups less markup cancellations are referred to as
net markups.
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Promotional
Markdowns
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A
lowering of the retail price hoping to encourage
greater store traffic. Unlike clearance
markdowns, promotional markdowns are regarded as an
integral part of some retailer’s offensive strategy
calculated to increase sales. Frequently the
promotional markdowns are temporary.
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Push
Money
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Bonus
money paid by a vendor or a retailer to sales people
for selling specially designated merchandise.
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Quick
Response (QR) Inventory System
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A
cooperative effort between retailers and their
suppliers aimed at reducing retail inventory while
providing a merchandise supply that more closely
addresses the actual buying patterns of consumers.
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Retail
Method of Inventory
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An
accounting technique for recording all inventory
inputs, including sales, purchases, markdowns, and so
on, at their retail values. Purchased items are
recorded at cost.
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Shrinkage
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The
gradual loss of inventory over time due to damage,
misplacement, or theft.
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Specialty
Stores
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Retail
outlets that maintain a large selection in a limited
line of merchandise.
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Stock
Book
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A
book, maintained by the buyer, in which are entered
additions to stock (inventory) in the form of
merchandise received from vendors, and merchandise
deductions which represent sales to customers.
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Stock
Keeping Unit (SKU)
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A
measure of an item of merchandise for inventory
management. In inventory control and
identification systems the (SKU) represents the
smallest unit for which sales and stock records are
maintained.
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Stock
Overage
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A
condition where the actual items on hand, as
determined by physical inventory is greater than the
amount indicated in the stock (inventory) records.
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Trade
Discount
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A
deduction from the agreed price, usually expressed as
a percentage or a series of percentages that is used
in commerce to encourage prompt payment of bills;
should not be entered in the books of account, nor
should it be considered to be a type of earnings.
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Workroom
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In
retailing, a non-selling area devoted to such support
services as apparel alterations, etc.
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Universal
Product Code (UPC)
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UPC
is a categorization where each item is given a
ten-digit number, pre-marked on the package by the
producer in the form of a bar code over ten
corresponding numbers.
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Retail
Price
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The
price at which goods originally are offered for sale.
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