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:: Retail Industry Audit Technique Guide (ATG) - Chapter 3:
Examination Techniques for Secific Industries (Video/DVD Rental Business)
Chapter
3:
Examination
Techniques
for
Specific
Industries
(Video/DVD
Rental
Business)
Introduction
The
video/DVD
industry
is
partially
made up
of
taxpayers
who want
to
establish
a store
to rent
video/DVDs
to the
public.
These
"mom and
pop"
stores
are
present
in both
metropolitan
and
rural
areas.
The size
of these
non-franchised
businesses
will
generally
run from
gross
receipts
of
$25,000
to
$500,000.
The
taxpayer
purchases
mass-produced
copies
of
master
versions
of
movies
in the
video/DVD
format.
Income
Small
rental
activities
are
sometimes
a
sideline
business
in a
grocery
or
convenience
store
and may
be cash
intensive.
The
examiner
should
be alert
to the
existence
of this
type of
activity
in an
existing
business.
A
helpful
technique
is to
document
the flow
of
receipts
from the
rental
of a
tape to
the tax
return,
and
tracing
the
income
flow.
The
examiner
should
include
questions
in the
initial
interview
regarding
exactly
how the
gross
receipts
were
determined.
These
tapes
are
purchased
from
wholesalers
and are
paid for
generally
by check
and
sometimes
by cash.
Watch
out for
illegal,
bootlegged
tapes/DVD.
These
may be
paid for
in cash
and will
usually
only
occur in
the
smaller
video/DVD
rental
locations.
As in
all
cases,
the
examiner
should
question
any cash
purchases
over the
threshold
amount
where no
information
reporting
(Form
1099)
was made
to the
supplier.
Cost of
Goods
Sold
Many
businesses
may
deduct
the cost
of
video/DVDs
as
purchases
in cost
of goods
sold.
The
taxpayers
are not
in the
business
of
selling
tapes.
They are
in the
business
of
renting
tapes;
therefore,
the
tapes
must be
depreciated.
Expenses
Damaged
or Lost
DVDs
The
shelf
life of
a
video/DVD
varies
depending
on the
frequency
of use.
After
several
months
of
renting
the
video/DVD
in the
store,
some
taxpayers
rent the
video/DVD
to
groceries
and/or
convenience
stores.
After
extensive
use of
the
video/DVD,
they may
be sold
outright
to
customers.
The
customers
may
damage
some
video/DVDs
after
several
uses.
The
taxpayers
may
claim
the
customers’
video/DVD
machines
may be
defective
or the
video/DVD
may be
left in
a hot or
cold car
before
returning
it to
the
video/DVD
store.
Natural
fatigue
on the
film
stripe
of the
tape
will
also
cause
the
tapes to
be
damaged.
The
business
should
be able
to
specifically
identify
tapes
that
were
destroyed
and have
a record
of the
date and
type of
damage.
The
business
will
also
maintain
a list
of
video/DVDs,
which
were
rented
but had
not been
returned
to the
store.
There
will be
records
for
collection
attempts
and this
could be
used to
determine
allowable
write-offs.
The
taxpayers
must
prove
that the
tapes
were
sold or
disposed
of
within
the year
before
they
would be
allowed
a
current
year
write
off.
This may
lead the
examiner
to
unreported
income
from the
sales of
tapes.
Depreciation
Revenue
Ruling
89-62
provides
the
proper
methods
of
deducting
the
video/DVDs.
It was
held
that
"video/DVDs
are
subject
to
section
167 of
the Code
and may
be
depreciated
in
accordance
with the
straight
line
method
over the
useful
life of
the
video/DVDs
in the
particular
taxpayer's
business.
Alternatively,
the
income
forecast
method
may be
used."
Section
168(f)
(3) of
the Code
provides
that
section
168 does
not
apply to
"any
motion
picture
film or
video/DVD
tape.
The
primary
position
to take
is to
allow
the
tapes to
be
depreciated
in
accordance
with the
straight
line
method,
using a
3 or 5
year
life,
depending
upon the
taxpayer's
business,
with a
half-year
convention.
Revenue
Ruling
89-62
allows
the
income-forecast
method
as an
alternative.
The
taxpayers
must
maintain
very
detailed
records
to
properly
apply
this
method
and is
usually
allowed
only
under
those
strict
conditions.
Video/DVD
retailers
sometimes
deduct
the
purchases
of tapes
as
purchases
and then
also
depreciate
the
tapes.
In other
words,
they
would
double
deduct
the tape
acquisitions,
and in
this
case an
adjustment
will be
made to
disallow
the
purchase
cost.
Be alert
to
convoluted
bookkeeping.
For
instance,
one
example
of this
involved
a
taxpayer
who
deducted
all of
their
tape
acquisitions
under
purchases,
depreciated
the
tapes
and then
indicated
they
backed
out the
deduction
by
listing
all of
the
tapes
purchased
since
they had
been in
business
in
ending
inventory.
The
examiner
was able
to
establish
that the
taxpayer's
ending
inventory
was
overstated
due to
tape
sales to
customers,
gasoline
stations
and
grocery
stores.
In a
Technical
Advice
Memorandum,
IRS said
that
movie
and TV
films
and
tapes
are
intangible
property
for the
purposes
of
section
179
deduction.
Therefore,
Section
179
deduction
is not
allowable.
Glossary
Bar
Code
Information
encoded
into a
pattern
of
varying-width
parallel
bars and
spaces
that can
be read
by a
scanner/bar-code
reader
and
interpreted
as a
numeric
or
alphanumeric
identification
code.
Common
symbologies
used in
retail
are
UPC-A
for
merchandise
marking
and Code
128
(also I
2 of 5)
for
shipping
containers.
Other
symbologies
used
include:
Code 39
and EAN.
See 2-D
Bar
Code.
Bar
Code
Density
The
number
of data
characters
per inch
(or
other
measure).
Bar
Code
Label
A label,
generally
both
human-
and
machine-readable
by an
automatic
scanning
device.
It is
often
used in
shipping.
Bar
Code
Reader
Device
that
reads
bar
codes;
implies
an
optical
device
such as
CCD
rather
than
laser.
Bar
Code
Scanner
Device
that
reads
bar
codes;
implies
a laser
device.
Cards
A record
of a
customer's
account
kept on
cards
for ease
of
handling
and
tracking.
This is
a small
version
of the
posting
of
ledger
cards
usually
filed by
date
instead
of by
customer
name to
facilitate
renewals.
When a
computer
system
is in
use,
this
copy may
be
listed
by
computer
instead
of on a
card.
Card
Close
The
total
number
of
past-due
customer
accounts
on a
particular
day
usually
expressed
as the
ratio of
expired
accounts
to
total.
Card
File
The
files
where
all of
the
store's
rental
agreement
cards
are
kept.
Cash
Drawer
The
drawer
where
the cash
and
checks
received
from the
day's
business
transactions
is
stored,
until
deposited
in the
bank.
Cash
Flow
The
amount
of money
generated
by a
business
less the
cash
expenses
of doing
business.
DVD
Digital
video
disc
player.
Credit
Authorization
and EDC
Utilities
Software
integrated
into a
POS
system
to
provide
access
to
credit
authorization,
check
authorization
networks,
and
settlement
banks.
POS
Point-of-Sale.
Can
refer to
the
location
in a
retail
store
where
consumer
sales
transactions
occur,
and to
the
sales
data
collected
there.
Also
called
scan
data.
POS
Register
Incorporates
products
normally
associated
with POS
systems
(e.g.,
computer,
printer,
monitor,
keyboard,
scanner,
cash
drawer,
card
reader,
etc.).
Promotional
Product
A
product
subject
to wide
variations
in sales
because
it is
often
sold
with an
incentive
such as
a price
reduction.
Often
refers
to
products
with
difficult-to-forecast
sales
based on
history.
Renewal
Card
The back
of the
last
copy of
the
rental
agreement
used for
payment
information
previously
called
Collection
or Route
Card.
Renewal
Date
The last
day when
a
customer
can make
a
renewal
payment
and keep
the
agreement
in good
standing.
Renewal
Ratio
The
percentage
of
agreements
renewed
to total
agreements
at the
end of
each day
and
calculated
in
units,
dollars
or both.
Returned
Check
A check
written
by a
customer
for
payment
of a
rental
agreement
that is
refused
by the
bank for
insufficient
funds,
closed
account,
etc.
Returned
Check
Log
A
listing
of the
returned
checks
to the
business
per day
or per
week.
Shrinkage
Losses
from
theft
and lost
product.
Refers
to
difference
between
actual
inventory
versus
what the
system
says
should
be in a
location.
Unit
Yield
The
total
dollars
of
actual
rental
revenue
plus any
special
charges
(delivery,
reinstatement,
etc.)
divided
by the
number
of units
on rent.
Units on
Rent
The
number
of items
on rent
in a
particular
store at
a
particular
time.
Also
known as
Balance
On Rent
(B.O.R.).
Valid
Rental
Agreement
A rental
agreement
in good
standing
between
a rental
company
and a
customer
for
merchandise
rental.
VCP
Acronym
for a
videocassette
player.
A
machine
that is
designed
for
playback
of
videocassettes
only and
does not
record.
VCR
Acronym
for
videocassette
recorder.
A
machine
that can
both
record
and play
back
programs.
Vendor
A supply
source
that a
business
uses to
acquire
goods to
rent.
Vertical
Rack
Audio
system
housed
in a
vertical
cabinet.
Video
Equipment
for the
reception,
recording
or
playback
of a
television
or
videocassette
picture.
Statistics
Bizstats.com
shows
that
almost
49% of
sole
proprietors
in the
video
tape and
disc
rental
business
report a
net
profit.
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