Latest IRS Targets - Cash Based Businesses
© by Greta P. Hicks, CPA
Source: IRS Audit Technique Guide for Mobile Food Vendors and Expresso Bars.
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:
- 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).
- 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 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.
- Documentation or an estimate of any bulk sales (sales by the pound
of unground beans) and any coffee removed for personal use.
- An estimate of losses due to spillage, theft, or any other similar
- 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.)
- 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.
- Determine whether any applicable sales taxes are included in the
- 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
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
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
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:
- Determine the ratio of "milk" based drinks for the vendor.
- Determine, if possible, the ratio of each size of drink and compute
an average number of ounces per drink.
- Determine the "shot" ratio: Each shot of espresso produces
about 11 ounces of liquid.
- 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.
- 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.
- 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
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
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a nationally known speaker and writer on solutions to IRS problems. To
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